Changing Regulatory Environment.

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CHAPTER 12: Imports, Customs, and Tariff Law

Importing is the process of entering goods into the customs territory of a country. The study of importing should not be approached from the perspective of an isolated transaction. Rather, importing should be viewed as an integral part of a global company’s operations. For instance, a chemical company might find that raw materials can be sourced from foreign suppliers at a net cost far less than if purchased at home. A leading apparel designer might ship garments to the United States that had been assembled in Honduras, from parts of clothing that were cut and sewn at plants in Hong Kong, from fabric that had been woven in China. An automobile company might ship cars to the United States from assembly plants in Mexico that used component parts sourced from Japan or Europe. A Japanese-owned electronics company might assemble televisions in the Caribbean using both Japanese and U.S. parts, with the finished products shipped back to U.S. markets. A large retailer might import foreign-made consumer goods, such as toys or appliances, because they are cheaper from overseas sources. U.S. distributors of Swiss watches, Danish cheese, or French wine might import these foreign brands because customers perceive them to be of superior quality. Each of these companies views the operation of their firm in a global context, and they are aware that their global strategy will be affected by the customs and tariff laws applicable to their products as these goods cross national borders.

Whereas the preceding chapters discussed the process by which nations regulate international trade, this chapter focuses on the specific problems of importing goods into the United States. It examines U.S. regulations governing the admission of goods into the country, the calculation of import duties, tariff preferences for developing countries, the marking requirements for goods, and the use of many duty-saving devices, such as foreign trade zones. The chapter begins with an explanation of how imports into the United States are supervised by the U.S. Bureau of Customs and Border Protection and how the customs and tariff laws are administered.

THE ADMINISTRATION OF CUSTOMS AND TARIFF LAWS

The customs and tariff laws of the United States are enacted by the U.S. Congress and are implemented and enforced by the U.S. Bureau of Customs and Border Protection, referred to in this book as U.S. Customs or simply Customs. Customs is an agency within the Department of Homeland Security and is headed by the Commissioner of Customs. The creation of the Department of Homeland Security in 2003 was a part of the largest reorganization of the American government in over fifty years. The Bureau of Customs and Border Protection was created by merging the functions related to border security that had previously been handled by the Department of Agriculture, the Immigration and Naturalization Service, the Border Patrol, and U.S. Customs (formerly a part of the Department of the Treasury). The agency’s duties are to prevent terrorists and terrorist weapons from entering the United States, enforce border security, assess and collect the tariff revenue of the United States, enforce the customs laws, which includes regulating the entry of products under quota or embargo, enforce the labeling statutes, supervise exports, administer duty-free zones, and perform other functions. As a law enforcement agency, U.S. Customs combats smuggling of narcotics and contraband and investigates tariff fraud cases. Customs has the authority to bar the entry of goods that violate patent, trademark, or copyright laws. The agency is responsible for the administration of customs laws throughout the customs territory of the United States, which includes Puerto Rico. In addition, U.S. Customs officers are assigned to U.S. embassies in many foreign countries to assist in the administration of U.S. customs laws.

Customs is divided into seven geographic regions, each headed by a regional commissioner. The regions are further divided into districts, each headed by a district director. Customs offices are located at the ports of entry, including major seaports, airports, inland ports, and border crossings. Within each district are field import specialists, who make initial determinations as to the entry of goods. They can seek advice from national import specialists. Some officers are specialists in particular types of products, such as textiles. The district director supervises all imports within the district and makes sure that imported goods are entered in accordance with the rules of the agency and decisions of the courts.

The Formal Entry

The formal entry refers to the administrative process required to import goods into the customs territory of a country. Goods have officially “entered” the United States only when the following requirements have been met.

1. The goods have arrived at a U.S. “port of entry.”

2. The goods are not of a type that is not permitted entry or from an embargoed country.

3. Delivery is authorized by Customs after inspection and release.

4. Estimated duties have been paid or a customs bond posted.

The process begins upon the arrival of the merchandise at a U.S. port of entry. Goods not processed for entry within fifteen days are sent to a warehouse as “unclaimed freight.” The goods may be entered by the owner, purchaser, consignee (the party to whom the goods are shipped or to be delivered), or licensed customs broker. A customs broker is an authorized agent, licensed by federal law, to act for and on behalf of importers in making entry of goods. (A broker is not needed to import goods for personal use.) Over 90 percent of all entries are made by customs brokers. A customs broker must possess a written power of attorney from the party making entry. Nonresident individuals and foreign corporations may make entry, but they are bound by much stricter rules. The entry process is not merely transporting the goods into the United States; it includes the filing of customs documents and the payment of duties.

Required Documentation.

When goods are entered, the entry documents must be filed within five days. The documents necessary to enter goods generally include the following items:

1. An entry manifest or merchandise release form (see the Entry/Immediate Delivery Form in Exhibit 12.1)

Exhibit 12.1: Entry/Immediate Delivery Form

2. U.S. Customs Entry Summary Form (Exhibit 12.2)

Exhibit 12.2: Entry Summary Form

3. Proof of the right to make entry (a bill of lading, air waybill, or carrier’s certificate)

4. The commercial invoice obtained from the seller (or a pro forma invoice, if the commercial invoice is temporarily delayed by the seller)

5. Packing slips to identify the contents of cartons

6. Other documents required by special regulations (e.g., certificate of origin, quota visa, textile declaration, etc.)

The Commercial Invoice.

A seller must provide a separate invoice for each commercial shipment entering the United States. The commercial invoice is required for all shipments intended for sale or commercial use in the United States. The invoice must provide all pertinent information about the shipment, in English, and be signed by the seller. One invoice can be used for installment shipments to the same consignee if the shipments arrive within ten days of each other. The invoice must include the following information:

• Names of the port of shipment and the destined port of entry

• Name of buyer and seller or consignee

• Common or trade name for the goods and their detailed description

• Country of origin

• Currency of payment

• Quantity and weight of the goods shipped

• Value of the goods accurately and correctly stated, including a breakdown of all itemized charges such as freight, insurance, packing costs, the costs of containers, any rebates and commissions paid or payable, and the value of any production assist

• A packing list stating in detail what merchandise is in each individual package

• Special information for certain classes of merchandise (e.g., bedspreads must indicate whether they contain any embroidery, lace, braid, or other trimming)

The Entry Summary and Immediate Delivery Forms.

Within ten working days, the importer must file these completed documents with Customs at the port of entry. The information on the form is used to determine the amount of duties owed, to gather import statistics, and to determine if the goods conform to other U.S. regulations.

Payment of Duties.

If import duties are assessed on the goods by U.S. Customs, the importer must deposit estimated duties with Customs at the time of filing the entry documents or the entry summary form. The duties must be in an amount determined by U.S. Customs, pending a final calculation of the amount actually owed. Payment to a customs broker does not relieve the importer of liability to pay the duties. The liability for duties constitutes a personal debt of the importer, and a lien attaches to the merchandise. In lieu of paying duties immediately, an importer may post a customs bond. This is more convenient for companies needing immediate delivery of their goods. A customs bond can be purchased for a single shipment or for all shipments over the course of a year and up to the amount stated in the bond. The purpose of the bond is to ensure the payment of duties on final calculation. In some cases, goods can be released for transportation or storage in-bond, meaning that the payments of duties are suspended until the goods are released for sale or use in the United States. There is no liability for duties on unordered or unclaimed merchandise.

Informal Entries.

Personal and some smaller commercial shipments valued at $2,000 or less may be cleared through an informal entry process. In this process, a bond is not required for entry, and import duties are payable immediately at the time of entry. Informal entries may be processed through the U.S. Postal Service. The letter carrier acts as the agent for U.S. Customs for the purpose of collecting import duties.

This practice has several advantages. Postal rates can be far less for smaller packages than commercial airfreight, and the entry process is quicker and less expensive, with no customs broker needed. The documentation and marking requirements are still strict, however, and the importer should check with the postal service before attempting a postal entry. A commercial invoice must accompany the shipment. In addition, many products have a $250 limit on postal entries; these include furniture, flowers, textiles, leather goods, footwear, toys, games, and many other items. Wool products and wearing apparel from the Pacific Rim countries require a formal customs entry regardless of value. If a mail article is found to contain merchandise subject to an import duty and the article is not accompanied by a customs declaration and invoice, it is subject to seizure and forfeiture.

Electronic Entry Processing.

In the late 1990s, Customs instituted a paperless entry process, known as the Automated Commercial System. It is designed to reduce costs to business and government and to speed the entry process. The system allows entry documents to be filed electronically through an automated hook-up between importers, customs brokers, and Customs via the Automated Broker Interface. Many companies, primarily the largest and more sophisticated importers and brokers, are already filing electronically.

Remote Location Filing.

Until recently, entry processing had to take place at the port where the goods were located. Thus, importers had to rely on the services of a broker at the port of entry, even if the goods were being entered in a distant location. Large importers who move goods through different ports asked Congress to permit entry processing from remote locations. The Remote Location Filing system allows brokers in all parts of the country to make remote entries at distant ports.

Liquidation and Protest

In a normal import transaction, assuming no errors or penalties are at issue, the entry will be liquidated. Liquidation is the final computation and assessment of the applicable duty on entered goods by Customs. This “closes the book,” making the entry complete. If Customs accepts the entry as submitted on the importer’s documents, liquidation occurs immediately. However, when Customs at the port of entry determines that additional duties are owed, a notice of adjustment is sent to the importer. The importer must respond to the notice, or the duty will be assessed as corrected. If a question or dispute arises concerning the goods themselves, as in the case of technical or unusual products, or in complex cases, the case may be referred to an import specialist familiar with that type of product. Either the importer or Customs officials may seek internal advice from the agency’s headquarters. Officially, the liquidation becomes effective, and the entry is closed, when it is posted at the “customs house” at the port of entry. A courtesy notice is sent to importers advising them of the liquidation, although this notice is not legally effective. If actual duties owed exceed the estimated duties paid at the time of entry, the importer must pay them within fifteen days of the posting of the notice of liquidation.

Time Limits on Liquidation.

Liquidation must occur within one year of entry. The time can be extended for good cause. An entry not liquidated within one year is deemed liquidated by operation of law. Under a deemed liquidation, the goods are dutied at the rate accepted on the entry summary form. A liquidation can be reopened within two years if there is evidence to suspect that the importer committed fraud.

Protesting Liquidations.

An importer that wants to dispute a liquidation made by Customs may file a protest with Customs at the port where the goods were entered within ninety days. An importer may not file a protest where no change was made by Customs to the entry as filed by the importer. Customs has thirty days to respond in cases where the goods have been denied entry; otherwise they have two years to act. Appeals can be made to Customs headquarters in Washington, D.C.

Judicial Review of Protests.

If Customs denies a protest—which is what usually happens—the importer may seek judicial review in the Court of International Trade. All duties assessed must first be paid, and the appeal must be filed within 180 days. The Court of International Trade is a specialized federal court located in New York City. Appeals from the Court of International Trade are made to the U.S. Court of Appeals for the Federal Circuit in Washington, D.C.

Enforcement and Penalties

The Bureau of Customs and Border Protection is a law enforcement agency charged with enforcing the tariff laws of the United States. U.S. Customs has broad powers to establish regulations, carry out investigations, and impose penalties. All care must be used in complying with customs requirements, and many experienced importers will tell you that they would no sooner make an error on a customs form than they would on their own tax returns.

The basic enforcement and civil penalty provisions of the customs laws are found in Title 19, Section 1592. The offenses set out here are civil violations calling for civil penalties imposed administratively by Customs. Criminal violations are addressed elsewhere in the U.S. Criminal Code. Section 1592 begins by setting out an importer’s basic responsibility: “No person may enter or attempt to enter any merchandise into the United States by means of any written document, electronic transmission of information, oral statement, or other act that is both material and false or which omits any material information affecting the entry.”

Making Materially False Statements to Customs.

An act or statement is “material” if it refers to the identity, quality, value, source, or country of origin of the merchandise, or if it affects the rate of duty charged or the item’s right to be imported into the United States. For instance, falsely stating that cigars of Cuban origin are from Honduras might allow them to illegally pass through customs when they otherwise would be denied entry, and stating that a textile product is decorated with embroidery, when it actually is not, might mean a considerable decrease in the lawful rate of duty.

A false statement or omission can be material even if it does not actually cause a change in the rate of duty. Identifying an imported fabric as “100 percent cotton” when in fact it is made of a blend of cotton and silk would be material even though it may or may not actually result in a change in the rate of duty collected. The statement or omission must also be false. The violation occurs whether the false statement or omission was made intentionally or negligently. There is no violation if the falsity resulted from simple clerical errors or reasonable mistakes of fact outside the control of the importer (such as where a foreign supplier unexpectedly includes merchandise in a sealed container that you were not aware was being shipped to you, and you had no way to find out) as long as the errors are not part of a pattern of negligent conduct. The penalty, however, does depend on whether the offense resulted from negligence, gross negligence, or fraud.

Negligent Violations.

A negligent violation is one in which the importer fails to use reasonable care, skill, and competence to ensure that all customs documents and statements are materially correct and all laws are complied with. It might result because the importer failed to accurately ascertain the facts or information required by Customs when making an entry. It could also result from a misinterpretation of customs regulations or a mistake in completing the customs documents. Negligence penalties can seem pretty severe: If duty has been lost, the penalty can be up to two times the loss of duty, but no more than the value of the goods. If no duty is lost, then the penalty can be as high as 20 percent of the value of the goods, depending on whether there were mitigating or aggravating circumstances.

In the following case, United States v. Golden Ship Trading Co., the importer was found negligent in misstating the country of origin of T-shirts even though she based her information on assurances made by her supplier.

Gross Negligence.

An importer commits gross negligence if there is “clear and convincing evidence” that the act or omission was done with actual knowledge or reckless disregard for the relevant facts and with disregard for the importer’s obligations under the law. The penalty is approximately twice that for negligent violations.

Civil Fraud.

Customs fraud is far more serious than negligence. A fraudulent violation exists where there is “clear and convincing evidence” that the importer knowingly made a materially false statement or omission while entering or attempting to enter goods into the United States. This might include intentionally giving a phony description of the goods being imported, understating their value by submitting a fake seller’s invoice or by concealing money paid to the seller, or altering the country of origin listed on a document. Although the act must have been done knowingly, it does not matter whether the importer intended to evade paying import duties. According to Customs guidelines, the agency will normally seek a penalty equal to 100 percent of the value of the goods, reduced to five to eight times the total loss of duty for mitigating circumstances. Where the fraud did not result in a loss of duty to the government, the minimum penalty sought will be 50 percent of the value of the goods to a maximum of 80 percent. Even greater penalties may be imposed where there has been an egregious violation, a risk to public health or safety, or the presence of aggravating factors. In no case may the penalty exceed the value of the merchandise. In many cases, Customs may seize the merchandise and either have it destroyed or sold at auction.

Crimes.

Criminal penalties for customs fraud and smuggling are set out in Title 18, Chapter 27, of the United States Code specifies a range of criminal activities, including the use of fraudulent customs documents, making false statements to a Customs officer, smuggling, conspiracy, money laundering, and many other acts. The law provides a maximum sentence of two years’ imprisonment, a fine, or both, for each violation. Anyone who willfully, and with the intent to defraud the United States, smuggles or attempts to smuggle goods into the country can receive a five-year prison sentence. Special criminal offenses apply to drug smuggling and to travelers entering the United States with merchandise in their baggage or on their person.

United States v. Golden Ship Trading Co.

2001 WL 65751 (2001) Court of International Trade

BACKGROUND AND FACTS

J. Wu entered three shipments of T-shirts purchased from Hui, who claimed that he operated a factory in the Dominican Republic. Hui furnished all the relevant information necessary for the importer’s custom house broker to prepare the import document and to obtain a visa permit for entry of wearing apparel into the United States. Wu signed the entry papers stating that the country of origin of the T-shirts was the Dominican Republic. Customs discovered that Hui produced the body of the T-shirts in China and shipped them to the Dominican Republic, where sleeves were attached and “Made in Dominican Republic” labels inserted. The finished shirts were then transshipped to the United States. According to law, merely attaching the sleeves did not make the shirts a product of the Dominican Republic. Chinese-made shirts could not have been imported without a textile visa, which Hui may not have been able to obtain. The government alleged that Wu acted without due care in determining the country of origin and sought penalties of $44,000. Wu did not dispute that the country of origin was China but denied that she was negligent and claimed that Hui had duped her.

BARZILAYJ.

Section 1592(e) describes the burden of proof that each side bears in a penalty action based on negligence. The United States bears the burden of establishing that the material false act or omission occurred; the burden then shifts to the defendant to demonstrate that the act did not occur as a result of negligence. See 19 U.S.C. §1592(e)(4). In this action, Customs has adequately demonstrated that the material false act occurred.

Since the court holds that the statements on the entry papers were both material and false, the only remaining issue is whether Ms. Wu has carried her burden that “the act or omission did not occur as a result of negligence.” To decide if the mismarking was the result of Ms. Wu’s negligence the court must examine the facts and circumstances to determine if Ms. Wu exercised reasonable care under the circumstances.

Ms. Wu admits she relied on the information provided by the exporter and accepted his representations that the Dominican Republic was the country of origin of the teeshirts because “all the documents that the exporter provided prior to entry stated the country of origin was the Dominican Republic.” Further, she claims that she was the victim of the exporter’s fraudulent scheme which was so elaborate that even Customs had difficulty discovering it. Ms. Wu points out that the exporter did have a t-shirt factory in the Dominican Republic and that the factory did perform some manufacturing operations on the imported t-shirts. Ms. Wu also claims “figuring out which (t-shirts) qualified as country of origin Dominican Republic and which did not required an entire team of Customs investigators, special agents and import specialists. Obviously, the exporter’s fraud in this case was well-concealed.” Furthermore, she contends, if Customs had difficulty investigating and uncovering the exporter’s falsifications, how could Ms. Wu, with far fewer resources and less expertise, be expected to know that the entry papers falsely reflected the country of origin of the imported t-shirts. Therefore, Ms. Wu claims, shewas justified in relying on the exporter’s entry information.

The court finds that Ms. Wu failed to exercise reasonable care because she failed to verify the information contained in the entry documents. Under the regulation’s definition of reasonable care, Ms. Wu had the responsibility to at least undertake an effort to verify the information on the entry documents. There is a distinct difference between legitimately attempting to verify the entry information and blindly relying on the exporter’s assertions. Had Ms. Wu inquired as to the origin of the imported t-shirts or, at minimum, attempted to check the credentials and business operations of the exporter, she could make an argument that she attempted to exercise reasonable care and competence to ensure that the statements on the entry documents were accurate. Instead, Ms. Wu applies circular reasoning to prove she was not negligent. She assumes she would not have been able to discover that the exporter was misrepresenting the county of origin and therefore was not negligent even though she made no attempt to verify. The critical defect with Ms. Wu’s argument is that it removes the reasonable care element from the negligence standard. The exercise of reasonable care may not have guaranteed success, but the failure to attempt any verification undercuts the argument that she would have been unable to determine the truth.

Ms. Wu failed to “exercise” reasonable care because she utterly failed to attempt to verify the exporter’s information. Indeed, Ms. Wu admits, and the evidence is uncontraverted, that she relied solely on the word of the exporter.

Q. What information did you rely on when you signed this document that indicates that the single country of origin of the imported items was the Dominican Republic?

A. I believe [sic] Pedro. He said he sent me all the documents and the documents said it’s made in the Dominican Republic so I just signed them.

Furthermore, Ms. Wu openly admits she did not inquire at all about the origin of the imported merchandise.

Q. Did you discuss with Mr. Hui (the exporter) where the fabrics from the t-shirts were made?

A. I never asked. I don’t [sic] know how to ask. I never asked it.

Although it is apparent Ms. Wu did not directly research the authenticity of the exporter’s claims, she argues that she employed the services of a licensed customs house broker and relied on the broker’s expertise to properly prepare the import documents. However, Ms. Wu did not attempt to verify or ascertain the correctness of the information prepared by the broker.

Q. Did you discuss with the broker where he got the information from?

A. I did not discuss it with him.

Even though Ms. Wu did not attempt to verify the country of origin, she still signed and certified the accuracy of the information contained in the entry documents. Ms. Wu’s reliance on the exporter and the broker does not remove the obligation to exercise reasonable care and competence to ensure that the statements made on the entry documents were correct.

The court finds that Ms. Wu’s failure to attempt to verify the entry document information shows she did not act with reasonable care and did, therefore, attempt to negligently introduce merchandise into the commerce of the United States in violation of 19 U.S.C. §1592(a)(l)(A) and, therefore, must pay a civil penalty for her negligence pursuant to 19 U.S.C. §1592(c)(3)(B).

With regard to the amount of the penalty, the court directs the parties to attempt to settle the matter by consultation guided by the court’s opinions in United States v. Complex Machines Works Co., 83 F. Supp. 2d 1307 (1999) and United States v. Modes, Inc., 826 F. Supp. 504 (1990) regarding mitigation.

Decision. Wu did not exercise reasonable care because she failed to verify the information contained in the entry documents. Customs could assess a penalty that took into account the mitigating circumstances of the case. Once the government proved the false act occurred, the burden shifted to Ms. Wu to prove that she was not negligent.

Case Questions

1. What was Wu’s motivation in stating that the shirts were made in the Dominican Republic?

2. What is the burden of proof? Must the United States prove that Wu was negligent or must Wu prove that she was not?

3. Can the importer (Wu) rely on the statements of the third party (here, the shirt exporter) to avoid responsibility?

Aggravating and Mitigating Circumstances.

The following are examples of the types of additional factors that Customs will consider in determining the amount of a penalty.

• Aggravating Factors: These include obstructing an investigation, withholding evidence, providing misleading information, prior improper shipments, and illegal transshipments of textiles to hide their actual country of origin.

• Mitigating Factors: These include errors committed by Customs itself that contributed to the violation; erroneous advice from a Customs official; cooperation with the investigation; immediate remedial reaction (e.g., payment of the duty voluntarily and immediately, discharge, or retraining of an offending employee); inexperience in importing (except in fraud cases); or a prior good shipment record. In addition, Customs may consider the ability of the importer to pay the penalty.

Enforced and Informed Compliance.

Customs and Border Protection takes a two-pronged approach to enforcement of the customs laws: enforced compliance and informed compliance. Enforced compliance refers to the active investigation of customs violations and the prosecution of violators. Informed compliance refers to “softer” mechanisms designed to place the burden of voluntary compliance on importers. Compliance with the customs laws is much like compliance with the income tax laws. Unless the majority of U.S. importers, like taxpayers, voluntarily comply with the customs laws, enforcement will be impossible. Congress recognized this when it passed the Customs Modernization and Informed Compliance Act of 1993 (called the Mod Act). It introduced the doctrine of informed compliance, which shifted to the importer a major responsibility to comply with all customs laws and regulations. It requires that importers, customs brokers, and carriers use reasonable care in complying with the law, in handling all import transactions, and in preparing all documentation for entered goods. Reasonable care means more than simply being careful. It means that those handling import transactions must be properly trained and that companies must establish internal controls over import operations to ensure compliance. When requirements are not understood, the importer should consult a licensed broker, customs law attorney, or U.S. Customs itself. Importers are expected to have enough information and knowledge to comply with the law. This includes having accurate information about the type of merchandise being imported, its value and origin, the identity of the seller, and so forth. It also requires importers to have a working knowledge of customs statutes, regulations, and rulings and U.S. Customs procedures.

In order to make informed compliance work, Customs recognizes that it has a responsibility to provide information, advice, technical assistance, and clear regulations to importers. Customs works closely with high-volume importers and those in problem or sensitive industries (e.g., textiles, automobiles, and steel) to assist them in developing their own corporate compliance programs.

The Reasonable Care Checklist.

In 1997, U.S. Customs published a checklist to give smaller and less experienced importers a better understanding of their obligation to use reasonable care (see Exhibit 12.3). Customs understood that a “black-and-white” definition of reasonable care is impossible because the concept depends on individual circumstances. The checklist is not a law or regulation; it merely helps importers to understand what is expected of them. Importers who fail to meet the reasonable care requirements on the checklist may be subjected to penalties for negligence.

Exhibit 12.3: Just How Informed Do You Have to Be? Reasonable Care Checklist for Importers

1. If you have not retained an expert to assist you in complying with U.S. Customs requirements, do you have access to the Customs Regulations (Title 19 of the Code of Federal Regulations), the Harmonized Tariff Schedule of the United States, and the GPO publication Customs Bulletin and Decisions? Do you have access to the Customs Internet Web site, Customs Electronic Bulletin Board, or other research service to permit you to establish reliable procedures and facilitate compliance with customs laws and regulations?

2. Have you consulted with a customs “expert” (e.g., lawyer, broker, accountant, or customs consultant) to assist in preparation of documents and the entry of the merchandise?

3. If you use an expert to assist you in complying with U.S. Customs requirements, have you discussed your importations in advance with that person and have you provided that person with full, complete, and accurate information about the import transactions?

4. Has a responsible and knowledgeable individual within your organization reviewed the customs documentation prepared by you or your expert to ensure that it is full, complete, and accurate?

5. Are identical transactions or merchandise handled differently at different ports or customs offices within the same port? If so, have you brought this to the attention of the appropriate customs officials?

6. Have you established reliable procedures within your organization to ensure that you provide complete and accurate documentation to U.S. Customs?

7. Have you obtained a customs ruling regarding the importation of the merchandise?

8. Do you know the merchandise that you are importing and have you provided a detailed and accurate product description and tariff classification of your merchandise to U.S. Customs? Is a laboratory analysis or special procedure necessary for the classification?

9. Have you consulted the tariff schedules, U.S. Customs’ informed compliance publications, court cases, or U.S. Customs rulings to assist you in describing and classifying the merchandise?

10. If you are claiming a free or special tariff treatment for your merchandise (e.g., GSP, HTS Item 9802, NAFTA, etc.), have you established a reliable program to ensure that you reported the required value information and obtained any required or necessary documentation to support the claim?

11. Do you know the customs value of the imported products? Do you know the “price actually paid or payable” for your merchandise?

12. Do you know the terms of sale; whether there will be rebates, tie-ins, indirect costs, additional payments; whether “assists” were provided, commissions or royalties paid? Have all costs or payments been reported to U.S. Customs? Are amounts actual or estimated? Are you and the supplier “related parties,” and have you disclosed this to U.S. Customs?

13. Have you taken reliable measures to ascertain the correct country of origin for the imported merchandise? Have you consulted with a customs expert regarding the country of origin of the merchandise?

14. Have you accurately communicated the proper country of origin marking requirements to your foreign supplier prior to importation and verified that the merchandise is properly marked upon entry with the correct country of origin?

15. If you are importing textiles or apparel, have you developed reliable procedures to ensure that you have ascertained the correct country of origin and assured yourself that no illegal transshipment (rerouting through a third country for illegal purposes) or false or fraudulent documents or practices were involved? Have you checked the U.S. Treasury’s published list of manufacturers, sellers, and other foreign persons who have been found to have illegally imported textiles and apparel products? If you have obtained your textiles from one of these parties, have you adequately verified the country of origin of the shipment through independent means?

16. Is your merchandise subject to quota/visa requirements and, if so, have you provided or developed a reliable procedure to provide a correct visa for the goods upon entry?

17. Have you determined or established a reliable procedure to permit you to determine whether your merchandise or its packaging bear or use any trademarks or copyrighted matter or are patented and, if so, that you have a legal right to import those items into, and/or use those items in, the United States?

18. If you are importing goods or packaging materials that contain registered copyrighted material, have you checked to ensure that it is authorized and genuine? If you are importing sound recordings of live performances, were the recordings authorized?

19. Have you checked to see that your merchandise complies with other government agency requirements (e.g., FDA, EPA/DOT, CPSC, FTC, Department of Agriculture, etc.) prior to or upon entry and procured any necessary licenses or permits?

20. Have you checked to see if your goods are subject to a Commerce Department dumping or countervailing duty determination and reported that to U.S. Customs?

SOURCE: Excerpted and adapted by the authors from TD-97-96 (1997), United States Customs.

Reporting Errors to Customs before an Investigation.

Congress has enacted a statute to encourage importers to voluntarily report their own possible violations of the customs laws. This is called a prior disclosure. If an importer admits its mistake and informs Customs of a possible violation before learning that it is being investigated, the penalties are limited. The importer must completely disclose the materially false statements or omissions and the circumstances of the violation. Any unpaid duties must be remitted immediately or within thirty days. However, an attorney should be consulted before doing so. Some prior disclosures have reportedly saved companies many millions of dollars in potential fines.

The Statute of Limitations.

The government is barred from bringing any action to collect an import duty after five years from the date of the violation involving negligence or gross negligence, or five years from the date of discovery of a violation involving fraud.

Record-Keeping Requirements.

Importers are required to keep records of all import transactions for five years from the date of entry and to give Customs access to those documents on demand. The records include all documents “normally kept in the ordinary course of business,” including sales contracts, purchase orders, government certificates, letters of credit, internal corporate memoranda, shipping documents, correspondence with suppliers, and any other documents bearing on the entry of the merchandise. It is highly recommended that any corporate importer establish a customs records compliance program to avoid penalties. The willful failure to keep records about the entry is punishable by the lesser of a $100,000 fine or 75 percent of the value of the merchandise. Even negligent record keeping is punishable by fines up to $10,000 or 40 percent of the value of the goods, whichever is less. There is an exception if the records were destroyed by an act of God. Concealment or destruction of records carries an additional $5,000 fine or up to two years’ imprisonment or both. U.S. Customs conducts audits to verify business records. Inspections can take place on reasonable notice to the importer. Documents can be seized by court order.

Judicial Enforcement of Penalty Actions.

In any action to collect a penalty, U.S. Customs acts as plaintiff in bringing suit in the Court of International Trade. Quite often, Customs will ask the court to consider all theories of culpability—negligence, gross negligence, and fraud—hoping to win on one or the other theory. The burden of proof in court depends on the violation. Fraud and gross negligence must be proved by “clear and convincing evidence.” In negligence cases, the government must prove only that the act or omission occurred; the burden then shifts to the defendant-importer to show that it did not occur as a result of negligence.

Binding Rulings

Imagine that you have an opportunity to sell imported women’s boxer shorts to a leading U.S. department store chain. They would like you to quote “your best price.” You learn that some women will wear the boxers as short pants, while others will wear the shorts as underwear. If you underestimate your costs, you will end up eating your shorts on the deal. The problem is that you are not sure whether Customs will consider the boxers to be “outerwear,” which is dutied at almost 18 percent, or “women’s slips and briefs,” which are dutied at less than 12 percent. Importers faced with a situation like this may make a written request for a binding ruling, also called a ruling letter, from Customs in advance of an entry. A binding ruling represents the official position of Customs with respect to the specific transaction for which it was issued. It is binding on Customs personnel until revoked. Customs does not publish public notice in advance of a ruling, and there is no opportunity for the public to comment on the issue.

Rulings are important to importers, especially those dealing in new or unusual merchandise that they have not imported before. They relieve them of the uncertainty of how the product will be treated by Customs or how much duty they will have to pay.

Binding rulings can be even more important where companies are considering the tariff consequences of restructuring their global manufacturing operations. Take another simple example. Assume you are trying to choose between Mexico and China as a site to produce bicycles for sale in the United States. The parts will come from many suppliers around the world. Among all the factors to be considered—labor costs, quality control issues, local tax rates, access to the U.S. market—there are also the tariff consequences. Will there be a difference in the tariff rate if you produce bicycles in China and import the completed bicycles into the United States rather than importing the parts into Mexico, assembling the bicycle there, and shipping to customers in the United States? This requires a working knowledge of complex tariff code provisions. Obtaining a ruling letter from Customs in advance will mean one less surprise later on.

A request for a ruling letter should be submitted in writing. It should contain all relevant information, and in some cases—like the boxer shorts case—the importer should send a sample of the article. The ruling is issued only on the basis of the exact facts given and ensures that the products described will be entered according to the terms set out in the letter. The letter applies only to the importer to whom it is addressed. (You can research ruling letters on the Customs Website.) Most rulings are issued within thirty to sixty days, although especially difficult ones can take up to nine months. Rulings are published in the Customs Bulletin.

Judicial Review

The role of the courts in reviewing the decisions and actions of U.S. Customs depends on whether Customs was involved in formal rulemaking applicable to the public at large or whether it was an informal action, such as the issuance of a binding ruling or an action affecting a single shipment of goods belonging to a single importer.

Judicial Review of Formal Rulemaking.

In United States v. Haggar Apparel Co., 526 U.S. 380, 119 S.Ct. 1392 (1999), Haggar shipped U.S.-made fabric to Mexico where it was cut and sewn into pants, then perma-pressed and returned to the United States for sale. According to U.S statutes (Section 9802 of the U.S. tariff schedules), component parts or materials made in the United States may be shipped to certain foreign plants for assembly and returned to the United States with a partial duty exemption. However, the materials may only be assembled and must not undergo further manufacturing or processing in the foreign country. Customs issued a regulation interpreting the statute, stating that perma-pressing was an additional step in manufacturing and “not incidental to the assembly process.” Customs issued the regulation using a formal rulemaking process (called “notice and comment” rulemaking) so it was applicable to all importers. In other words, as a formal rule it was more than just a ruling regarding a single entry by an individual importer. It was promulgated only after a public comment period, it was published in the Code of Federal Regulations, and it had the “force of law.”

The Supreme Court held for the government, stating that Customs’ decision to define perma-pressing as “not incidental to the assembly process” was perfectly reasonable. The Supreme Court held that courts must give “judicial deference” to the formal regulations of U.S. Customs where those regulations are a “reasonable interpretation” of an ambiguous statute. This is known as “Chevron deference,” taken from the important case of Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 104 S.Ct. 2778 (1984).

Judicial Review of Binding Rulings.

Haggar did not address the scope of judicial review of informal decisions such as binding rulings. These and other routine decisions are made on a case-by-case basis every day—thousands every year—by Customs officials around the country. It might be a binding ruling about the tariff classification of imported merchandise or a decision about an entry when the goods arrive at a U.S. port. If an importer seeks review of a Customs decision in the courts, to what extent will the court give deference to Customs’ decision? Should the court consider that the agency is an expert on customs matters and simply defer to its original decision? Or should the court undertake its own analysis and reach its own decision independent of the agency’s determination? The following U.S. Supreme Court decision, United States v. Mead, defines the scope of judicial review of binding rulings, tariff classifications, and other “informal” day-to-day decisions of Customs.

Pre-importation Judicial Review in Emergency Circumstances.

Normally, an importer cannot seek court review until a shipment has been entered and a protest denied by Customs. Under limited circumstances, an importer may seek review in the courts prior to entry only where extraordinary circumstances could cause irreparable injury to the importers and severe business disruption and substantial costs would result if a decision were not reached. Other cases have stated that if an importer can show that a Customs ruling threatens to “close the importer’s doors,” then review will be permitted in advance of entering the goods.

DUTIABLE STATUS OF GOODS

Tariffs, restraints on imports, and other import controls are applied to goods according to the item’s dutiable status. The dutiable status of goods is determined by (1) the classification of the article (what it is), (2) the customs value of the article, and (3) the country of origin of the article (the country it comes from for purposes of determining the tariff rate or applicability of a quota). An accurate estimate of the duties owed on imports provides information essential for business planning, development of cost estimates, and pricing and marketing decisions.

United States v. Mead Corp.

533 U.S. 218 (2001) United States Supreme Court

BACKGROUND AND FACTS

Mead had imported “day planners” for several years. They had entered duty-free under HTSUS 4820.10. The classification covers “[R]egisters, account books, notebooks, order books, receipt books, letter pads, memorandum pads, diaries and similar articles.” HTSUS 4820.10 has two subcategories. Items in the first, “[d]iaries, notebooks and address books, bound; memorandum pads, letter pads and similar articles,” were subject to a tariff of 4 percent at the time in controversy. Articles in the second, covering “other” items, were free. The planners had been classified in the “other” subcategory. They included a calendar, a section for daily notes, a section for telephone numbers and addresses, and a notepad. The larger models also included a daily planner section, plastic ruler, plastic pouch, credit card holder, and computer diskette holder. A loose-leaf ringed binder held the contents, except for the notepad, which fit into the rear flap of the day planner’s outer cover. In a binding ruling, Customs changed the classification of the planners to “bound diaries” under the first subcategory, with a 4 percent import duty. Mead argued that the day planners were not diaries and were not bound and that the planners should be classified in an “other” subcategory that was duty-free. After entering the goods and paying the duties, Mead filed a protest. When the protest was denied, Mead appealed. The Court of International Trade issued a summary judgment for the government. The Court of Appeals reversed, holding that the planners were not “bound diaries” on the basis of the dictionary meaning of those words. The court held that it owed no deference to Customs’ classification rulings under the Chevron and Haggar court decisions, but was free to decide the classification issue anew as a matter of law. The court noted that those cases involved formal regulations that carried the force of law, while classification rulings apply only to the specific transaction at issue. The U.S. Supreme Court agreed to hear the case.

JUSTICE SOUTER

We agree that a tariff classification has no claim to judicial deference under Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 104 S.Ct. 2778, 81 (1984) there being no indication that Congress intended such a ruling to carry the force of law, but we hold that under Skidmore v. Swift & Co., 323 U.S. 134, 65 S.Ct. 161 (1944), the ruling is eligible to claim respect according to its persuasiveness [most citations omitted].

* * *

“[T]he well-reasoned views of the agencies implementing a statute ‘constitute a body of experience and informed judgment to which courts and litigants may properly resort for guidance,’ Skidmore, and [w]e have long recognized that considerable weight should be accorded to an executive department’s construction of a statutory scheme it Is entrusted to administer…” Chevron. The fair measure of deference to an agency administering its own statute has been understood to vary with circumstances, and courts have looked to the degree of the agency’s care, its consistency, formality, and relative expertness, and to the persuasiveness of the agency’s position…. Justice Jackson summed things up in Skidmore:

The weight [accorded to an administrative] judgment in a particular case will depend upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control.

* * *

There is room at least to raise a Skidmore claim here, where the regulatory scheme is highly detailed, and Customs can bring the benefit of specialized experience to bear on the subtle questions in this case: whether the daily planner with room for brief daily entries falls under “diaries,” when diaries are grouped with “notebooks and address books, bound; memorandum pads, letter pads and similar articles,” HTSUS subheading 4820.10.20; and whether a planner with a ring binding should qualify as “bound,” when a binding may be typified by a book, but also may have “reinforcements or fittings of metal, plastics, etc.,” Harmonized Commodity Description and Coding System Explanatory Notes to Heading 4820. A classification ruling in this situation may therefore at least seek a respect proportional to its “power to persuade,” Skidmore. Such a ruling may surely claim the merit of its writer’s thoroughness, logic, and expertness, its fit with prior interpretations, and any other sources of weight.

* * *

Since the Skidmore assessment called for here ought to be made in the first instance by the Court of Appeals for the Federal Circuit or the CIT, we go no further than to vacate the judgment and remand the case for further proceedings consistent with this opinion. It is so ordered.

Decision. The Court of International Trade and the Court of Appeals for the Federal Circuit must grant a limited degree of deference to the tariff classification ruling letters issued by U.S. Customs, according to the Skidmore standard. The degree of deference depends on the agency’s thoroughness, the validity of its reasoning, its expertise, and its “power to persuade.”

Comment. On remand to the Court of Appeals, the court found Customs’ ruling somewhat “unpersuasive” under the Skidmore standard. Noting that it was the court’s job to determine the meaning of language used in the tariff schedules, the court relied on the dictionary definitions of “bound” and “diary,” and, for a second time, entered a judgment for Mead.

Case Questions

1. When a court reviews a classification ruling, is the court free to disregard the position of Customs and consider all the evidence anew? Must the court give complete deference to Customs’ rulings? What does the court say is the correct standard of review?

2. What was the legal rationale the Supreme Court used in holding for Mead?

3. What about the product—day planners—that gave rise to the appeal? Do you think that a loose leaf “day planner” is a “bound diary”? Could you locate these in the tariff schedules and determine the current rate of duty?

Determining the dutiable status of an article can require importers to negotiate a maze of regulations. For importers who enter a wide variety of products or materials or who enter them from many different countries, the potential for problems increases significantly. For U.S. exporters trying to enter goods into foreign countries, the regulatory headaches can become nightmarish. Lessons learned from importing into one country are not necessarily transferable when importing into another.

In recent years, worldwide efforts have attempted to make customs procedures and import regulations more uniform, more understandable, and easier to follow. Simplified, uniform rules would make it easier for both importers and their foreign suppliers to plan their transactions in advance and to comply with complicated laws and regulations. These efforts are beginning to result in the development of uniform rules for classifying and valuing imports and for determining their country of origin. These include a standardized system for classifying products (officially known as the Harmonized Commodity Description and Coding System), the WTO Agreement on Customs Valuation (1994), and the WTO Agreement on Rules of Origin (1994).

The Harmonized Tariff Schedule

All goods entering the United States are dutiable unless specifically exempted. Duties and restrictions on imports are based on the exact type and classification of goods being imported. Since 1989, goods entering the United States have been classified according to the Harmonized Tariff Schedule of the United States (HTSUS or HTS). The harmonized system was part of a worldwide effort, spanning nearly two decades, to standardize tariff nomenclature according to the Harmonized Commodity Description and Coding System. Under this uniform system, in effect in most trading nations of the world, all goods are classified by their name, description, or use. Goods that fall into a certain classification in one country will be similarly classified in all countries that follow the harmonized system. Thus, a company that knows the classification of its product in the United States, for example, is easily able to determine the classification of its product in most other countries. The harmonized system does not set the tariff rate, and tariff rates are not necessarily uniform between countries. Tariff rates on goods are set by each nation according to the classification of those goods. The harmonized system was developed by the World Customs Organization, an international organization located in Brussels, representing over 170 nations. In the United States, the HTSUS is maintained by the International Trade Commission and is available online directly or through U.S. Customs and Border Protection.

Using the Harmonized Tariff Schedule.

The HTSUS divides products into approximately 5,000 tariff classifications, ranging from basic commodities and agricultural products to manufactured goods. It is organized into twenty-two sections, covering products from different industries. Sections are broken down into ninety-nine chapters, each covering the commodities, materials, and products of a distinct industry. The chapters are arranged in a progression from crude and natural products such as livestock and agricultural products through advanced manufactured goods such as vehicles and aircraft. The following list provides a few examples:

Chapter 1

Live animals

Chapter 9

Coffee, tea, spices

Chapter 22

Beverages, spirits, vinegar

Chapter 25

Salt, sulfur, earths, and stone

Chapter 30

Pharmaceuticals

Chapter 44

Wood and articles of wood

Chapter 51

Wool, fine or coarse animal hair

Chapter 52

Cotton

Chapter 62

Articles of apparel, accessories not knitted

Chapter 63

Other textile articles, sets, worn clothing

Chapter 76

Aluminum and articles thereof

Chapter 84

Nuclear reactors, boilers, machinery, and mechanical appliances

Chapter 85

Electrical machinery, sound recorders, television image

Chapter 88

Aircraft, spacecraft, parts thereof

Chapter 94

Furniture, bedding, lamps

Chapter 97

Works of art, collectors’ pieces

Chapters 98/99

Reserved for special tariff classifications (e.g., imports that enter the United States only temporarily or for service and repair, etc.)

Chapters are broken down into headings, subheadings, and tariff items. Tariff items are denoted by eight-digit codes. In the United States, the schedules break out to ten digits to allow for compiling of statistical data on imports.

Chapter :

first two digits

Heading :

First four digits

Subheading :

first five or six digits

Tariff items :

first eight digits

Statistical break:

ten digits (the ninth and tenth digit)

Consider the example in Exhibit 12.4 Tents made of synthetic fibers—such as nylon—used for backpacking are classified as item 6306.22.10. They are found within subheading 6306.22, for tents of synthetic fibers, heading 6306 for “Tarpaulins, awnings and sunblinds, tents, sails for boats…” and chapter 63 for “Other textile articles.” Countries that use this international coding system have “harmonized” their classifications to six digits at the subheading level. After the first six digits, each country assigns its own numbers.

Exhibit 12.4: Harmonized Tariff Schedule of the United States (2010) (Rev.1)

Heading/Subheading

Stat Suffix

Article Description

Unit of Quantity

Rates of Duty

General

Special

6306

Tarpaulins, awnings and sunblinds; tents; sails for boats, sailboards or landcraft; camping goods:

Tarpaulins, awnings and sunblinds:

6306.11.00

Of cotton (369)

8.8%

Free (CA,IL,MX) 4.4% (JO)

90%

6306.12.00

Of synthetic fibers (669)

8.9%

Free (CA,IL,MX) 2.3% (JO)

90%

6306.19.00

Of other textile materials

5.2%

Free (CA,E*,IL, MX)

40%

Of artificial fibers (669)

1.3% (JO)

Other(899)

Tents:

6306.21.00

Of cotton

8.8%

Free (CA,IL,MX) 4.4% (JO)

90%

6306.22

Of synthetic fibers:

6306.22.10

Backpacking tents

No. kg

0.5%

Free (A,CA,E,IL,J,MX)

90%

6306.22.90

Other

8.9%

Free (CA,IL,MX)

90%

Screen houses

2.3% (JO)

Other (669)

6306.29.00

Of other textile materials

3.2%

Free (CA,E*,IL,J*,JO,MX)

40%

Sails:

6306.31.00

Of synthetic fibers

0.4%

Free (A,CA,E,IL,J,MX)

30%

6306.39.00

Of other textile materials

0.4%

Free (A,CA,E,IL,J,MX)

30%

Pneumatic mattresses:

6306.41.00

Of cotton

3.8%

Free (CA,IL,JO,MX)

25%

6306.49.00

Of other textile materials

3.8%

Free (A,CA,E,IL,J*,JO,MX)

25%

Other:

6306.91.00

Of cotton

3.8%

Free (C AIL,JO,MX)

40%

6306.99.00

Of other textile materials

Free (CA,E*,IL,J*,MX) 1.5% (JO)

78.5%

Annotated for Statistical Reporting Purposes

General Notes [edited for student use]

3. Rates of Duty. The rates of duty in the “Rates of Duty” columns designated 1 (“General” and “Special”) and 2 of the tariff schedule apply to goods imported into the customs territory of the United States as hereinafter provided in this note

a) Rate of Duty Column 1.

i) Except as provided in subparagraph (iv) of this paragraph, the rates of duty in column 1 are rates which are applicable to all products other than those of countries enumerated in paragraph (b) of this note. Column 1 is divided into two subcolumns, “General” and “Special,” which are applicable as provided below.

ii) The “General” subcolumn sets forth the general or normal trade relations (NTR) rates which are applicable to products of those countries described in subparagraph (i) above which are not entitled to special tariff treatment as set forth below.

iii) The “Special” subcolumn reflects rates of duty under one or more special tariff treatment programs described in paragraph (c) of this note and identified in parentheses immediately following the duty rate specified in such subcolumn. These rates apply to those products which are properly classified under a provision for which a special rate is indicated and for which all of the legal requirements for eligibility for such program or programs have been met. Where a product is eligible for special treatment under more than one program, the lowest rate of duty provided for any applicable program shall be imposed. Where no special rate of duty is provided for a provision or where the country from which a product otherwise eligible for special treatment was imported is not designated as a beneficiary country under a program appearing with the appropriate provision, the rates of duty in the “General” subcolumn of column 1 shall apply.

vi) Products of Insular Possessions (omitted)

v) Products of the West Bank or Gaza Strip (omitted)

b) Rate of Duty Column 2. Notwithstanding any of the foregoing provisions of this note, the rates of duty shown in Column 2 shall apply to products, whether imported directed or indirectly, of the following countries and areas:

Cuba North Korea

c) Products Eligible for Special Tariff Treatment.

i) Programs under which special tariff treatment may be provided, and the corresponding symbols for such programs as they are indicated in the “Special” subcolumn, are as follows:

Generalized System of Preferences

A, A* or A+

United States–Australia Free Trade Agreement

Automotive Products Trade Act

United States–Bahrain Free Trade Agreement Implementation Act

Agreement on Trade in Civil Aircraft

North American Free Trade Agreement:

Goods of Canada, under the terms of general note 12 to this schedule

Goods of Mexico, under the terms of general note 12 to this schedule

United States–Chile Free Trade Agreement

African Growth and Opportunity Act

Caribbean Basin Economic Recovery Act

E or E*

United States–Israel Free Trade Area

Andean Trade Preference Act or

Andean Trade Promotion and Drug Eradication Act

J, J* or J+

United States–Jordan Free Trade Area Implementation Act

Agreement on Trade in Pharmaceutical Products

Dominican Republic–Central America–United States

Free Trade Agreement Implementation Act

P or P+

Uruguay Round Concessions on Intermediate

Chemicals for Dyes

United States–Caribbean Basin Trade Partnership Act

United States–Morocco Free Trade Agreement Implementation Act

United States–Singapore Free Trade Agreement

United States–Oman Free Trade Agreement Implementation Act

United States–Peru Trade Promotion Agreement Implementation Act

After locating the article in the schedule, the importer can determine the tariff rate. The schedule is divided into two columns (see Exhibit 12.4). Column 1 contains a general rate applicable to imports from NTR (formerly MFN) nations, and a special rate applicable to one or more special tariff programs. The special rate applies to goods coming from developing countries under the Generalized System of Preferences, to goods coming from Canada or Mexico under the North American Free Trade Agreement, or to goods imported from the Caribbean Basin or Israel. Column 2 rates are the original Smoot–Hawley rates applicable to non-NTR countries under the Tariff Act of 1930, although few countries fall in this category today.

Tariffs are imposed on imports either on the basis of ad valorem, specific, or compound rates. The most common type of tariff is the ad valorem rate, based on a percentage of the value of the materials or articles imported. A specific rate is a specified amount per unit of weight or measure. A compound rate is a combined ad valorem and specific rate.

The Classification of Goods

Tariff rates are based on an article’s classification. To classify a product, you must know what your product is or how it will be used and where it falls in the tariff schedules. This is not as easy a task as it might seem. The schedules include every kind and category of product on earth. They include consumer goods ranging from “Articles for Christmas festivities and parts thereof” to “Electromechanical domestic appliances”; textile products ranging from “Cotton, not carded or combed, having a staple length under 28.575 mm” to “Men’s or boys’ suits… of worsted wool fabric… having an average fiber diameter of 18.5 microns or less”; industrial equipment ranging from “Bookbinding machinery” to “Nuclear reactors”; and electronic products from “Ballasts for discharge lamps or tubes” to “Laser imaging assemblies.” Finding your product among these is like walking a maze.

The problem is compounded because many products appear to fit into more than one classification. For example, should sleeping bags be classified as “Camping goods,” “Sporting goods,” or as “Articles of bedding and similar furnishing…fitted with springs or stuffed”? This is an area where reasonable minds can differ. Naturally, importers will argue that their products should fall into the classification that carries the lowest tariff rate. U.S. Customs, whose job it is to collect the tariff revenue of the United States, will want to classify the products at the highest rate. (Initially, the importer makes the classification by listing it on the entry form filed with Customs, who must then accept or reject the classification. Of course, the importer is bound by the informed compliance standard to use reasonable care in making its classification.) It is especially difficult for importers to classify a product if they are importing it for the first time or if it is a newly designed product. The problem is complicated by the fact that at any time Customs can “change its mind” and decide to reclassify an article, despite having accepted another classification of the same article in the past.

To illustrate how difficult it is to classify an article, consider the following case, Camel Manufacturing Co. v. United States, 686 F. Supp. 912 (Ct. Int’l. Trade 1988), involving the import of camping tents. At the time, the tariff schedules had no category specifically for “tents.” The importer and Customs disagreed over the other possibilities, which were sporting goods and miscellaneous textiles. Incredibly, the decision turned on the judge’s definition of what is a “sport.” Although the case was decided under the old schedules (now replaced by the harmonized schedule), it remains one of the authors’ favorites. No case better illustrates the unpredictability of customs classifications and the importance of advance planning.

Understanding Tariff Descriptions: The Common Meaning Rule.

Articles are described in the tariff schedules in several ways: by common name (known as an eo nomine description), by a description of the article’s physical characteristics, by a description of its component parts, or by a description of the article’s use.

To understand the meaning of terms used in the tariff schedules, the courts look to the common meaning of the articles described. According to the cases, the common or popular meaning of terms used in the tariff schedules applies unless Congress clearly intended a commercial or scientific meaning to apply or unless there is a different commercial meaning that is definite, uniform, and in general use throughout the trade. Courts will often examine the legislative history of the tariff act and will consult dictionaries and encyclopedias to determine the common meaning of the terms used (e.g., is an anchovy commonly understood to be the same thing as a sardine). The courts also rely on scientific authorities and expert witnesses during the trial.

Determining the common meaning is not always so simple. In Texas Instruments v. United States, 518 F. Supp. 1341 (Ct. Int’l. Trade 1981), aff’d. 673 F.2d 1375 (C.C.P.A. 1982), the court was faced with determining the common meaning of the term “watch movement.” The plaintiff, Texas Instruments, Inc., had entered solid-state electronic watch modules and electronic watches. The articles consisted of an integrated circuit chip, a capacitor, a quartz crystal, a liquid crystal display for digital readouts, and plastic cases within which the modules were encased. Because digital watches had not yet been invented at the time the tariff schedule was enacted by Congress, the court upheld Customs’ determination that the common meaning of “watch movement” in the horological industry did not include these electronic modules. The court believed that Congress could not have intended the term “movement” to include the mere vibration of a quartz crystal in a digital watch. In addressing the impact of technological development on Customs law, the Court of International Trade stated that

Camel Manufacturing Co. v. United States

686 F. Supp. 912 (1988) Court of International Trade

BACKGROUND AND FACTS

The plaintiff imported nylon tents into the United States. The tents were designed to hold up to nine people and weighed over 30 pounds, including carrying bag, stakes, and frames. The floor sizes ranged from 8 feet by 10 feet to 10 feet by 14 feet, and when folded for carrying the tents were approximately 50 inches long. It was undisputed that the tents were used as shelter by people who wish to camp outdoors, either purely for that purpose or for the purpose of engaging in other outdoor activities such as fishing, hunting, and canoeing. The importer entered the tents as “sports equipment” carrying a 10 percent ad valorem import duty. U.S. Customs ruled that the tents were properly classifiable as “textile articles not specially provided for” and imposed a duty of 25 cents per pound plus 15 percent ad valorem. Upon liquidation, the importer appealed.

JUDGE WATSON

The basic question before the court is whether or not the activity in which the tents are used, which we shall call by the name of “camping out” is a sport, which would then lead to the conclusion that these tents are sporting equipment.

In a previous opinion, The Newman Importing Co., Inc. v. United States, 415 F. Supp. 375 (1976), this court decided that certain light tents used in backpacking were sports equipment because the activity of backpacking was found to be a sport. In this action, the court was given a generous range of opinions regarding what it is that makes an activity a sport. Seven witnesses testified on behalf of the plaintiff and two witnesses testified on behalf of the defendant. The witnesses had a wide range of familiarity with the use and manufacture of tents. Although these opinions were extremely interesting, the fact remains that in the end the question of defining the term “sporting equipment” is really one of legal interpretation for the court.

The rationale used in the Newman Importing case will not suffice here because these tents are not suitable for backpacking. The court finds that these tents are too heavy for that particular activity and, in fact, are generally used by persons who are camping in the outdoors and are not subject to strict limitations of weight in the tenting equipment which they can take with them. In the absence of persuasive proof regarding any special attributes of these tents which may contribute to their use in backpacking, the court finds it quite reasonable for the Customs Service to have excluded them from the category of backpacking tents on the basis of their weight and carrying size.

The basic question before the court is whether the general activity of camping out, i.e., taking up temporary residence in the outdoors, is a sport within the meaning of the Tariff Schedules.

The court is unable to expand its view of the term “sports” to include the activity of camping out. To do so would require a definition of the term so loose that it would cover almost any purposeful activity engaged in by humans in a natural setting. If it were simply a question of whether an activity had a certain degree of challenge and skill then the activity of gardening, which has in it a good measure of challenge, skill, and struggle and offers in innumerable ways the “joy of victory and agony of defeat,” would also have to be considered a sport. This tells us that as a matter of simple logic and meaning, it does not appear that the term “sport” can be carried past the point which was expressed in the Newman case.

It follows that these tents are not “sports equipment” within the meaning of the tariff law.

For the reasons given above, it is the opinion of the court that plaintiff’s claim for classification must be denied and judgment must issue dismissing that claim.

Decision. The importer’s classification was rejected and the decision of the government upheld. The tents were not properly classifiable as “sporting goods” because the tents were designed for camping out, which was held not to be a sport. Affirmed by the U.S. Court of Appeals for the Federal Circuit, 861 F.3d 1266 (1988).

Case Questions

1. What method does the court use to determine the meaning of an item listed in the tariff schedule? What is the meaning of the term “sports equipment?” Why are these backpacks not sports equipment?

2. Compare the classification of the tents under the old schedules used in this case, with the newer classification in the harmonized code in Exhibit 12.4. What are the differences?

3. What are the implications of this case for the importer?

The courts cannot be asked to restructure the tariff schedules by judicial fiat in order to accommodate scientific and engineering innovations which far transcend the vision and intent of the Congress at the time of the enactment of the tariff schedules. It is true… that it is an established principle of customs law that tariff schedules are written for the future as well as for present application and may embrace merchandise unknown at the time of their enactment. It must be borne in mind, however, that…in applying a tariff provision to an article, unknown at the time of the enactment thereof, such an article must possess an essential resemblance to the characteristics so described by the applicable tariff provision.

Accordingly, the court ruled that the solid-state electronic module was not a “watch movement.”

Dictionary definitions are often used to interpret the tariff schedules. In C. J. Van Houten & Zoon v. United States, 664 F. Supp. 514 (Ct. Int’l. Trade 1987), the court ruled that tariff schedule items for “bars or blocks” of chocolate weighing 10 pounds or more did not apply to imports of molten, liquid chocolate imported into the United States in tank cars. Rather, the molten chocolate was to be classified as “sweetened chocolate in any other form.” After consulting several dictionaries for the common meaning of the terms “bars and blocks,” the court concluded that this meant only solid materials.

Determining the Classification of Products: Questions of Law and Fact.

Determining an article’s tariff classification typically involves two steps. First, you must interpret the common meaning of the terms described in the tariff schedules. Second, you must look at the facts to determine if the imported articles in question fall within the particular category described in the schedules. Courts like to say that the first step in defining tariff language is a “question of law,” and the second step is a “question of fact.”

Classification by Actual or Principal Use.

The tariff schedules describe articles by name, physical characteristics, or by use. When an article is described by both its use and by name, the use provision is generally deemed to be more specific, and often controls. Principal use is that use to which articles of the kind being imported are usually put. When an article might have several uses, the principal use controls. Principal use is the use that is greater than any other single use of the article.

An article may be classified according to the actual use intended for the article. To classify according to actual use, the product must be used for the purposes listed in the schedule. The actual use must be stated to Customs at the time of entry, and the imported article must actually be used in that manner. Proof of actual use must be furnished to Customs within three years of entry.

Using the General Rules of Interpretation

The General Rules of Interpretation (GRI) are an integral part of the HTSUS and govern its use. Anyone attempting to locate a product in the schedule must first consult the six required GRI rules. A summary of the rules is given later in this section.

The six rules must be applied in numerical order. To determine how an article is classified, first consult GRI 1. This requires that an article be classified according to the four-digit heading under which it is specifically and completely described or according to any relative section or chapter notes. Most imported goods can be classified according to GRI 1.

Consider Exhibit 12.4. Heading 6306 includes “Tarpaulins, awnings and sunblinds; tents; sails for boats …” If the article is specifically and completely stated in the heading, as are “tents,” then you may proceed to look at the six-digit subheading and eight-digit tariffitem levels. Thus, “backpacking tents” would be classified under 6306.22.10.

Notice that GRI 1 also requires that you consult the official notes found at the beginning of each of the twenty-two sections and ninety-nine chapters. The notes define specific terms used in the section or chapter (such as the terms “suit” or “ensemble” when used in reference to sets of apparel). They also list specific goods that are either included or excluded from that section or chapter. For instance, Chapter 94 covers “Furniture, bedding, mattresses, mattress supports, cushions…,” but the notes to Chapter 94 state: “This chapter does not cover…pneumatic or water mattresses …dentists’ chairs… toy furniture….”

In the event that the goods cannot be classified solely on the basis of GRI 1, the remaining rules may then be consulted. They must be applied in sequence beginning with GRI 2 and proceeding in order through GRI 6. The rules deal with problems that arise when an article could conceivably be classified under more than one heading and for classifying mixtures and articles made up of component parts.

The following rules have been edited for ease of study. Consult the GRI for the official text. Study them carefully, and be sure you are able to apply them.

GRI 1. Classification shall be determined according to the terms of the headings and any relative section or chapter notes and, provided such headings or notes do not otherwise require, according to GRI 2–6.

GRI 2. (a) An article described in a four-digit heading includes the completed, finished article as well as one that is incomplete or unfinished, provided that the incomplete or unfinished article has the essential character of the complete or finished article. Articles that are entered unassembled shall be classified as the assembled article. For example, a shipment of an unassembled bicycle will be dutied as a finished bicycle, provided that all of the parts needed to make a completed bicycle arrive in one shipment.

(b) Any reference in a heading to a material or substance shall include mixtures or combinations of that material or substance. Any reference in a heading to goods made from a certain material shall include goods made wholly or partly of that material. Goods consisting of more than one material shall be classified according to GRI 3.

GRI 3. When goods are classifiable under two or more headings, the article shall be classified as follows:

(a) The heading that provides the most specific description shall be preferred to headings that provide more general descriptions. (This is known as the Rule of Relative Specificity.)

(b) Mixtures, composite goods consisting of different materials or made up of different components, and goods put up in sets for retail sale, which cannot be classified by referring to 3(a), shall be classified as if they consisted of the material or component that gives them their essential character.

(c) When goods cannot be classified by reference to 3 (a) or (b), they shall be classified under the heading that occurs last in numerical order among those that equally merit consideration.

GRI 4. Goods that cannot be classified according to the above rules shall be classified under the heading for goods to which they are most akin.

GRI 5. In addition to the foregoing, the following rules apply:

(a) Camera cases, musical instrument cases, gun cases…and similar containers, specially shaped or fitted to contain a specific article, suitable for long-term use and entered with the article for which they are intended, shall be classified with such articles when of a kind normally sold therewith.

(b) Packing materials and containers entered with the goods therein shall be classified with the goods, unless the materials or containers are clearly suitable for repetitive use.

GRI 6. The classification of goods in the subheadings shall be determined according to the terms of the subheading and any related notes, and only subheadings at the same level are comparable.

The Rule of Relative Specificity.

Recall that GRI 1 requires us to classify a product according to the four-digit heading. But suppose a product could arguably be classified under more than one heading? The rule of relative specificity, found in GRI 3(a), provides that where an article could be classified under more than one heading, it must be classified under the one that most specifically describes the item. Moreover, we must only compare the language of the headings, without reference to any of the subheadings. Only after determining that an article is classifiable under a certain heading can you then proceed to find the proper subheading. For instance, assume you are importing electric toothbrushes. There are two possible classifications. Heading 8509 includes “electromechanical domestic appliance with self-contained motor” dutied at 4.5 percent. Heading 9603 includes “brooms, brushes, including brushes constituting parts of machines,” which are duty free. Which is the correct classification? The answer is heading 8509 because it more specifically describes the items than does 9603. This is despite the fact that at the eight-digit level, 9603.10.90 includes “toothbrushes, shaving brushes, Hairbrushes….” We must first determine the most specific four-digit heading, and the description “electromechanical domestic appliance with self-contained motor” is more specific than “brooms, brushes…” In addition, where items could be classified under more than one heading, a description by name is more specific than a description of a class of merchandise. For example, tools used by a hair stylist would be classified as “shavers and hair clippers with self-contained electric motor” under heading 8510 because this description is more specific than “electromechanical tools for working in the hand with self-contained electric motor” under 8508.

Classification by Essential Character.

Suppose an article is made of two or more different materials or components. There is no heading that specifically and completely describes the entire article, but there are several headings that describe the individual materials or components. If two or more headings each describe only certain materials or components of the article, GRI 3(b) requires that the article be classified under the heading that describes those materials or components that give the article its essential character (“essential character” is not defined in the GRI). This method is helpful to determine the classification of mixtures of chemicals, foodstuffs, and other substances or materials blended together, assuming that there is no classification that fits the mixture. The rule also applies to composite goods. Composite goods are goods made up of more than one component or material. For instance, imagine a typical notebook computer that also contains a standard AM/FM radio receiver. Should it be classified as “Reception apparatus for radio telephony” under heading 8527 or as an “Automatic data processing machin[e]” under section 8471? If the notebook computer imparts the essential character to this odd contraption, it would probably be classified under 8471.

In Pillowtex Corp. v. United States, 111 F.3d 1370 (Fed. Cir. 1999), the court considered the tariff classification of comforters made from a 100 percent cotton shell and filled with white duck down. The court held that the down fill should control the classification because the essential character of the comforters was derived from the insulating ability of the filling, not from the shell. Cases involving the essential-character test are very fact intensive; they turn on a detailed analysis of the facts of the case.

Classification of Items Packaged for Retail Sale as a Set.

The essential-character test is also used when “goods are put up in sets” for retail sale. In order for a product to qualify as “goods put up in sets,” according to the definition in the Harmonized Tariff Schedule, (1) there must be no heading in the tariff schedules providing for the set as a whole; (2) there must be two or more different materials or articles classifiable under different headings; (3) they must be packaged together to meet a particular need or carry out a specific activity; and (4) they must be put up in a manner suitable for retail sale to the user without further repacking. According to this definition, a set of twelve spoons would not be a set (they are not different articles), but different types of food sold as a frozen meal would be a set.

In the following case, Better Home Plastics Corp. v. United States, 916 F. Supp. 1265 (Ct. Int’l. Trade 1996), the court had to determine whether a shower curtain set was classified under the heading for “Curtains” or under the heading for “Tableware, kitchenware, other household articles and toilet articles, of plastics…Other: Curtains and drapes including panels and valances.” Notice how the court applies the General Rules of Interpretation and the essential-character test.

Classification at the Subheading Level.

Only after an article has been classified at the heading level should the subheadings be consulted. When comparing two or more different subheadings within the same heading, the rules set out in GRI 1–5 (relative specificity, essential character, etc.) must still be followed. Articles must be compared at equal subheading levels, so that only six-digit subheadings are compared to other six-digit subheadings, and so on.

Tariff Engineering

Tariff engineering is the process of modifying or engineering your product prior to importation for the purposes of obtaining a lower rate of duty. The general rule established by the U.S. Supreme Court and followed for well over 100 years is that an article is to be classified according to its condition at the time it is imported. Thus, generally, tariff engineering is an acceptable practice. As far back as 1881, the Supreme Court stated that “if the manufacturer uses… bleaching processes in order to make his sugars more saleable, why may he not omit to do so in order to render them less dutiable; nay, why may he not employ an extra quantity of molasses for that purpose?” Merrit v. Welsh, 104 U.S. 694 (1881).

Better Home Plastics Corp. v. United States

916 F. Supp. 1265 (1996) Court of International Trade

BACKGROUND AND FACTS

Plaintiff, Better Home Plastics Corp., imported shower curtain sets. The shower curtain sets consisted of an outer textile curtain, an inner plastic magnetic liner, and plastic hooks. The plastic liner prevented water from escaping while the shower was in use. The liner was color coordinated to match the outer curtain and added to the set’s decorative appearance. The textile curtain was intended to be decorative and did not block the water from getting out on the floor. The curtain was also semitransparent, permitting the color of the plastic liner to show when the curtain and the liner were drawn. Better Home Plastics sold the sets to budget stores at prices ranging from $5.00 to $6.00, and retailers resold them at prices from $9.00 to $12.00. Customs classified the merchandise under the provision for the set’s outer curtain at a duty of 12.8 percent according to Chapter 63, Subheading 6303.92.0000 of the Harmonized Tariff Schedule (HTSUS). Better Home Plastics asserted that classification of the set was properly determined by the set’s inner plastic liner under Chapter 39, Subheading 3924.90.1010, HTSUS, at a duty of 3.36 percent ad valorem.

DICARLO, CHIEF JUDGE

The General Rules of Interpretation (GRI) govern the classification of the imported shower curtain sets under the HTSUS. GRI 1 establishes the general presumption for classification under the rules. GRI 1 provides that the headings and relative section or chapter notes determine the classification of the imported merchandise, so long as those headings or notes do not require otherwise.

GRI 3 governs where the merchandise at issue consists of more than one material or substance, such as a textile curtain and an inner plastic liner, as here. GRI 3 mandates that, when “goods are, prima facie, classifiable under two or more headings,” the court must classify the merchandise in question pursuant to the heading providing the most specific description. This is known as the rule of relative specificity. An exception to this rule exists. When, however, two or more headings each refer … to only part of the items in a set put up for retail sale, those headings are to be regarded as equally specific…even if one heading provides a more complete or precise description of the goods. Accordingly, the rule of relative specificity does not apply when two of the headings each refer only to part of the items within the set.

Goods put up in sets for retail sale, which cannot be classified according to the most specific heading, are classified by the “component which gives them their essential character” (the essential character test). Better Home Plastics contends the court must apply the essential character test, in classifying the applicable merchandise. Application of the test, Better Home Plastics asserts, would mandate classification of the set on the basis of its inner plastic liner pursuant to Subheading 3924.90.1010, HTSUS….

Defendant contends the essential character of the curtains are embodied in the textile curtain. Defendant raises numerous arguments to support its position, particularly that (1) the plastic liner is replaceable at 1/3 to 1/4 the price of the set; (2) the consumer purchases the set because of the decorative function of the outer curtain, and not for the protection afford by the liner; and (3) the liner is only employed for the limited period that someone is utilizing the shower, whereas the decorative outer curtain is employed, at a minimum, when the bathroom is in use, and as much as 24 hours a day. Defendant also contends Better Home Plastics’ invoice description supports Customs’ classification. Pursuant to the invoice description, the set is sold as “Fabric Shower Curtain and Liner.” Therefore, defendant argues, this description serves as an admission that the curtain provides the essential character of the set.

Although the court agrees that the curtain in the imported set imparts a desirable decorative characteristic, nonetheless, it is the plastic liner that provides the indispensable property of preventing water from escaping the shower enclosure. The liner (1) prevents water from escaping when the shower is in use; (2) protects the fabric curtain from mildew and soap scum; and (3) conceals the shower and provides privacy when the shower is in use. Further, the plastic liner can serve its intended function without the outer curtain and contributes to the overall appearance of the set. The outer curtain, in contrast, merely furthers the set’s decorative aspect. The court therefore concludes the essential character of the set is derived from the plastic liner.

Defendant’s other contentions are also unpersuasive. The manner in which the set is invoiced does not definitively determine which component provides the essential character of the set. The invoice description is intended to characterize the shipped item; it is not a declaration of the relative importance of its component parts. Finally, while the court takes into consideration the relative cost of the component parts, this point alone is not dispositive, nor very persuasive against the competing arguments.

It is the essential character of the set—derived in part from the plastic’s ability to repel water—that denotes the set’s utility, purpose, and accordingly, character. Inclusion of the textile curtain within the classification for the plastic liner does little to change the qualities or the basic nature of the set in meeting this purpose.

The court finds Better Home Plastics has overcome the presumption of correctness accorded to Customs, and the shower curtain sets were improperly classified under subheading 6303.92.0000, HTSUS. In addition, the court agrees with Better Home Plastics’ proposed classification of the sets under subheading 3924.90.1010, HTSUS.

This decision is limited to its facts, i.e., that the set at issue is at the low end of the shower curtain market. The court does not offer an opinion on the proper classification of sets targeted to a different market segment.

Decision. When articles are made up of component parts, or are in sets, and their parts are referred to in two equally specific headings, then the rule of relative specificity does not apply, and their classification must be determined by which part gives the article its essential character. In this case, the shower liner imparted the essential character to the set.

Comment. Judge DiCarlo’s opinion was affirmed by the U.S. Court of Appeals in Better Home Plastics Corp. v. United States, 119 F.3d 969 (Fed. Cir. 1997).

Case Questions

1. What are the two main components of this “set”? If they had been sold separately, how would each have been classified?

2. What is the proper rule for determining the classification of a set?

3. What is the “rule of relative specificity,” and why was it not used here?

4. Why would Better Home spend the time and money to contest Customs’ classification?

Tariff engineering permits importers to design their products or to enter their goods at any step in the manufacturing or assembly process, in order to obtain a lower rate of duty.

Of course, there are some limits on tariff engineering. There must be no fraud or deception, the goods must be correctly described on the entry documents, and they must be honestly presented to Customs for inspection if requested. In Heartland By-Products, Inc. v. United States, 264 F.3d 1126 (Fed. Cir. 2001), the importer added molasses to sugar syrup in Canada and removed it after the syrup was imported into the United States. The syrup with molasses entered free from U.S. tariff-rate quotas on sugar syrup imports. Customs maintained that there was no other purpose for adding molasses except to avoid the quota, that the molasses was a “foreign substance,” and that adding it was not a genuine step in the manufacturing process. Since the molasses was later returned to Canada to be reused for the same purpose, Customs maintained that the process was done for “disguise or artifice” to circumvent the customs laws. There was no evidence that Heartland ever falsified or concealed the identity of its sugar syrup, its method of manufacture, or its use. The Court of Appeals agreed with Customs’ argument and upheld its reclassification of the syrup.

Customs Valuation

The customs value, often called dutiable value, of all goods entered into the United States must be established and reported to U.S. Customs at the time of entry. All relevant facts and terms of the contract of sale that affect value must be disclosed. Dutiable value is defined by U.S. law as the transaction value of the goods. The transaction value of the merchandise is the price actually paid or payable for the merchandise when sold for exportation to the United States, plus the following amounts if not included in the purchase price: (1) packing costs (including containers, covers, and labor for packing) incurred by the buyer, (2) any selling commission incurred by the buyer, (3) the value of any “assist,” (4) any royalty or license fee that the buyer is required to pay as a condition of sale, and (5) the proceeds of any subsequent resale of the merchandise that accrues to the seller. Transaction value does not include international freight charges, insurance or customs brokerage fees, inland freight after importation, charges for assembling or maintaining the goods after importation, or import duties. Charges for transporting the goods in the country of exportation (e.g., from the seller’s factory to the port) are also excluded when these charges are identified separately on the seller’s invoice. Transaction value is not affected by whether the sales contract called for CIF or FOB payment terms. If the price is expressed as CIF, the freight and insurance will be deducted; if FOB, the freight and insurance were not included anyway.

Importers are often required to pay royalties or license fees to the holders of copyrights, trademarks, or patents for the privilege of importing merchandise subject to those rights. Design and engineering fees may have to be paid to foreign firms separately from payments to the actual producer of the product. Sometimes these payments are made through the seller or exporter of the merchandise. When such payments are made “as a condition of sale of the imported merchandise for exportation to the United States,” they are included in transaction value. For instance, if a firm imports blue jeans manufactured in Hong Kong and as a condition of sale makes royalty payments to the designer of the jeans in Paris, the royalty would be included in the transaction value of the merchandise.

Agency Commissions.

The importance of transacting business through a foreign agent is stressed many times in this text. Agents are used both by sellers attempting to export to foreign markets and by buyers attempting to source materials or goods from foreign suppliers. The terms of the relationship between the importer and the agent can have a distinct impact on the calculation of transaction value. Although commissions paid to a buying agent (an agent of the buyer/importer) are generally not included in transaction value, payments made to or for the benefit of the seller or seller’s agent are included. Customs carefully scrutinizes the relationship between U.S. importers and their buying agents to be sure that dutiable value is accurately reported.

In Monarch Luggage Co. v. United States, 715 F. Supp. 1115 (Ct. Int’l. Trade 1989), the importer successfully structured a business transaction so that the buying commissions were excluded from transaction value. Although representatives of Monarch traveled to the Far East several times a year to meet with their suppliers, inspect their facilities, and place orders for luggage, they nevertheless maintained a local agent there. Under a written agreement, the agent was to locate the best sources for luggage and visit the suppliers to determine the quality of the luggage, but could place orders only at Monarch’s direction. The agent coordinated payment for the luggage and arranged transportation according to Monarch’s explicit instructions. The supplier and not the agent absorbed the loss of defective merchandise. The agent bore no risk of loss to the goods and never took title to them. The agreement further stated that “the agent shall never act as a seller in any transaction involving the principal.” Most importantly, Monarch made the payments to its agent directly and separately and not as a part of the invoice price paid to the supplier of the luggage. In other words, the agent was in fact a representative of the buyer and not an agent of the seller. The fees paid to the agent were not included in dutiable value.

Production Assists.

Importers will occasionally provide some form of production assistance to a foreign manufacturer or producer from whom they are purchasing goods. Production assists, also called dutiable assists, are goods, services, or intangibles furnished by the importer to a foreign producer, free or at a reduced price, for use in producing merchandise for import and sale in the United States. Examples of assists include (1) materials and component parts incorporated in or used in the production of the imported merchandise; (2) machinery, tools, dies, or molds; and (3) engineering, development, artwork, and design, or plans and sketches performed outside the United States and that are necessary for production. The value of an assist made to a foreign firm must be included in transaction value when the goods are imported into the United States. Production assists might be provided when a foreign firm needs special equipment or machinery to manufacture custom or specially designed goods. It might reduce costs by putting to use underutilized equipment belonging to the importer, while taking advantage of the foreign producer’s low-cost labor or economies of scale. Assists might also allow the importer some greater control over the quality of the finished product. Assists are often used as part of a plan for contract manufacturing—a business arrangement in which the production of goods is contracted or “outsourced” by one firm to a manufacturing firm, often overseas. They also result from multinational companies with operations in many countries. A multinational may have research and development facilities in one country, derive parts from other countries, and conduct final assembly in yet another country. These companies should maintain accurate accounting and documentation of all assists.

In Texas Apparel Co. v. United States, 698 F. Supp. 932 (Ct. Int’l. Trade 1988), the importer provided sewing machines to a Mexican manufacturer and paid the cost of repairs to the machines. The machines were used to produce garments sold to the importer in the United States. The court held that if the machines were supplied to the Mexican firm free of charge or at a reduced cost, then the value of the machines had to be included in the dutiable value of the garments as an assist. In Salant v. United States, 86 F. Supp. 2d 1301 (Ct. Int’l. Trade 2000), the importer provided free rolls of fabric to a foreign shirt manufacturer for use in making shirts for sale back to the importer. The court upheld customs regulations under which the value of the assist included the value of the fabric that went into the shirts as well as the value of the scrap fabric discarded as waste because including all of the fabric was more in keeping with “generally accepted accounting principles.”

Other Methods of Calculating Dutiable Value.

When the transaction value of imported merchandise cannot be determined, Customs will use the value of identical or similar merchandise. The identical or similar merchandise used in the comparison must have been recently sold for export to the United States at the same level of trade (manufacturer to distributor, distributor to retailer, for example) and in quantities similar to the entry being valued.

If dutiable value cannot be determined by any of these methods, Customs will utilize the deductive value or computed value methods. Deductive value is the resale price of the goods (including packaging costs) in the United States after importation, less international and inland freight, insurance, customs duties, brokerage fees, commissions, and expenses of refining, assembling, or further manufacturing incurred in the United States. The final method for calculating the value of imports gives the computed value. Computed value is calculated by adding the costs of raw materials, processing or fabricating, overhead, labor costs, packing costs, the value of any assist, and an amount for profit.

Currency Exchange Rates.

If imported products are invoiced in a foreign currency, customs valuation is not based on the actual amount paid to the foreign supplier in U.S. dollars according to the exchange rate obtained by the importer. Rather, the goods will be valued in dollars based on the exchange rate certified by the Federal Reserve Bank of New York on the day of export from the foreign country.

Rules of Origin

Imagine that it is 1989 and that your trading company has firm commitments from buyers in the United States to take all of the ostrich chicks that you can provide during the next year. After considerable searching and time spent traveling the world, you find an ostrich hatchery in England. You enter into a sales contract with the hatchery, with payment to be made under a confirmed letter of credit. Your bank pays the seller cash on the documents, and the chicks arrive peeping and squawking at a U.S. port of entry. The chicks are entered with their country of origin listed as Great Britain. An astute customs inspector realizes that the chicks could not possibly have “originated” in that country and corrects the country of origin to South Africa where the eggs obviously originated. You agree that the fertilized eggs originated in South Africa but argue that their incubation and hatching in Great Britain amounts to a “substantial transformation” and that Great Britain therefore became the country of origin. U.S. Customs ruled that the processing of the eggs in Great Britain was a natural biological consequence of the initial fertilization of the eggs in South Africa, that the chicks continued to be a product of South Africa, and that they are prohibited from entering the United States under a U.S. law banning the import of products from South Africa. (The ban was lifted in the early 1990s following the end of apartheid and political changes in South Africa.) This not-so-hypothetical case illustrates how critical it is to know the proper rules of origin needed to determine the country of origin of imported goods.

Definition and Purposes of Rules of Origin.

Rules of origin are the national laws and regulations of administrative agencies, usually customs authorities, which are used to determine the country of origin of imported products. No importing country will permit goods to be imported unless the country of origin of the goods is properly determined and reported to customs authorities.

In the United States, rules of origin are administered and enforced by U.S. Customs and Border Protection. The country of origin is used to determine the following:

• The normal tariff rate on an import

• Whether an import is subject to a preferential tariff rate or an increased rate

• Whether an import is subject to antidumping or countervailing duties

• Whether an import is subject to a quota, embargo, or other trade restriction

• The applicability of government procurement rules

• The proper country of origin labeling to be affixed to the product

• Statistical information

At first thought, one would think that determining the country of origin would be pretty simple. If a product is made in one country, entirely through processes and from raw materials and components originating there, the country of origin is not difficult to determine. Bananas grown in Honduras and shipped directly to supermarkets in the United States are products of Honduras. Plywood sheets glued and pressed in Brazil, from trees grown in Brazil, are obviously products of Brazil. Men’s shirts that were cut and sewn in China, from fabric dyed and woven there, from yarn spun there, that was made completely from cotton grown there, are products of China. But as with our ostrich chicks, it is not always so easy. The country of origin is not merely the country from which the goods were purchased or from where they were shipped. If that were the case, one could enter Italian leather products into the United States at the lower Mexican tariff rate by simply routing them through Mexico. In today’s global economy, raw materials and component parts circle the earth, finding their way into assembly lines and manufacturing plants stretched around the world. Thus for most manufactured, processed, or assembled articles, the country of origin can only be determined by resorting to the rules of origin in effect in the importing country. The rules of origin vary from country to country, and from product to product. They can be complex, arcane, and often require firms to seek professional advice or to obtain an advance ruling from customs authorities.

Types of Rules of Origin.

There are two general types of rules of origin, non-preferential and preferential. Non-preferential rules of origin are those that determine the country of origin of goods imported from countries that have been granted normal trade relations status (NTR, formerly “most favored nation”) by the importing country. This applies to most trade between developed countries that are not part of a free trade area or customs union. For instance, trade between the United States and Europe, or China, is on NTR terms. Preferential rules of origin are those that determine the country of origin on goods imported from countries that have been granted a trade preference by the importing country. A trade preference is some advantage or favorable treatment (usually a reduced tariff or duty free treatment) granted by one country to the imports of another country. Preferences usually result from a bilateral or regional free trade agreement, or from a trade preference program for developing countries. The North American Free Trade Agreement, among Canada, Mexico, and the United States, is an example of a regional trade agreement with its own rules of origin. Every free trade agreement and preference program has its own rules that determine when goods will qualify for free trade or preference status. (See Exhibit 12.4 for a list of U.S. tariff preferences in effect at the time of this writing.) Some countries, such as the United States, also have separate rules for imports of textile and apparel, government procurement, and automobiles. To complicate matters, the rules of origin differ according to the purpose for which they are being used. Rules used to determine the rate of duty on imported goods, for example, may be different from the rules of origin used to determine country of origin labeling of those goods. As such, we caution that no reader should rely on the general principles discussed in the following sections, but should seek professional advice, obtain a customs ruling, or be prepared to carefully research the rules of origin applicable to their specific transaction. The various rules of origin can be found in the harmonized tariff schedules of most countries (in the United States, the HTSUS) and by reference to free trade agreements and to the rules and decisions of customs authorities and courts. In the United States, there are many court decisions interpreting the rules of origin.

The General Rule in the United States.

If an article is wholly the growth, product, or manufacture of one country, then the country of origin is that country. In other words, the country of origin is that single country where an article is wholly and completely produced or manufactured entirely from raw materials originating in that country. Of course, few products today are wholly made in one country entirely from materials derived there. More and more products are subjected to manufacturing, processing, and assembly operations on a global scale. Agricultural commodities grown in one country may be processed into food in another. Steel produced in one country may shipped to another country to be galvanized, or transformed or processed into wire, steel plates, girders, or automobile parts. An automobile destined for the United States may be assembled in Latin America or Canada from parts and materials that originated in or were assembled in dozens of countries. Some products can involve hundreds or thousands of component parts that have been manufactured and assembled in plants located on several continents. But there can be only one country of origin for customs purposes, even for products that undergo manufacturing operations in several different countries. Importers are therefore expected to accurately track the movement of materials and understand the complex manufacturing or assembly processes, which in turn allows them to accurately determine an article’s country of origin. This can be especially difficult where manufacturing is subcontracted to foreign companies in distant regions of the world, and the customs entry is done by a distributor or retailer, such as Walmart, who may not be completely familiar with the manufacturing process.

The Substantial Transformation Test

If an article is not wholly the growth, product, or manufacture of one country, then the country of origin is that country where the article last underwent a substantial transformation. The meaning of the term can only be understood by looking at its history.

For a century, the courts of the United States have held that a substantial transformation occurs when the original article or product loses its identity as such and is transformed into a new and different article of commerce having “a new name, character, or use” different from that of the original item. In 1908, the U.S. Supreme Court ruled that imported cork had not been substantially transformed when it was dried, treated, and cut into smaller sections for use in bottling beer. The Court stated, “Something more is necessary…. There must be a transformation; a new and different article must emerge, having a distinctive name, character or use. This cannot be said of the corks in question. A cork put through the claimant’s process is still a cork.” Anheuser-Busch Brewing Association v. United States, 207 U.S. 556 (1908). Since then, many courts have tried to interpret this phrase and to apply it to many different products and manufacturing operations.

The name, character, or use test is used to determine the country of origin for tariff purposes (other than in specialized cases, such as those falling under the North American Free Trade Agreement), as well as to determine how foreign-made products are to be marked or labeled. U.S. law strictly requires that every foreign-made article imported into the United States be marked or labeled in English so as to indicate the country of origin of the article to the ultimate purchaser.

Suppose an article is taken from Country A to Country B, where it is subjected to a refining process that combines it with other materials. If the process in Country B amounts to a substantial transformation so that a new product emerges with a new “name, character, or use,” then the article may be entered into the United States at the rate of duty applicable to Country B’s products, and marked as “Made in Country B.” For example, if stainless steel bars are made in Korea and shipped to Germany (or any other NTR country) where they are turned into fine cutlery, it can enter the United States under the tariff rate for German cutlery and be labeled “Made in Germany” if the processing in Germany amounted to a substantial transformation that created a new and different article of commerce with a new “name, character, or use.” Similarly, if foreign raw materials are imported into the United States and put through a manufacturing process that substantially transforms them into a product with a new “name, character, or use,” the new product need not be marked as of foreign origin when sold to the ultimate purchaser. In other words, the foreign raw materials were transformed into a product of the United States.

The landmark case Gibson-Thomsen Co. v. United States, 27 C.C.P.A. 267 (1940)[BB] involved the application of the “name, character, or use” test under the marking and labeling laws of the United States. The court ruled that when wooden handles and blocks were imported into the United States from Japan, then drilled with holes into which American bristles were inserted, and with the final product being sold in the United States as toothbrushes and hairbrushes, the imported wooden components had “lost their identity in a tariff sense” and had been transformed into products of the United States. The court took account of the fact that the bristles, which had been of U.S. origin, were a key component of the new product. Because the transformation took place in the United States, the wooden handles did not have to be marked as having originated in Japan. Gibson-Thomsen is often cited by courts today.

Since 1940, the courts have interpreted and refined the “name, character, or use” concept. Some courts have looked to see if a “new article of commerce” emerges from the transformation. For instance, in a 1970 case, a court ruled that unfinished furniture chair parts were substantially transformed by the importer into chairs that were new and different articles of commerce. Similarly, wooden sticks imported into the United States and then set into liquid ice cream and frozen have been held to be substantially transformed into a new product having a new name, character, and use. In a 1960 case, a court ruled that the winding of typewriter ribbon onto imported spools resulted in a substantial transformation of the spools because the imported spool became an integral part of the whole product with which it was combined. In 1984, Customs used the same rationale for deciding not to impose country of origin marking requirements on the plastic spools and shells in which audio cassette tape is wound. Although many cases look to see if the name commonly given the transformed article has changed, a product’s name is generally considered to be only one of several factors to take into account. Greater emphasis is usually placed on whether the essential character—sometimes said to be the “essential nature”—of the product or its use has changed.

Many of the modern cases also look to see whether the substantial transformation has resulted in an increase in value, called the value-added test. In National Juice Products Association v. United States, 628 F. Supp. 978 (Ct. Int’l. Trade 1986), a U.S. company had imported evaporated orange concentrate and blended it with water, orange oils, and fresh juice to make frozen orange concentrate. The blending and processing in the United States had added only a 7 percent value to the orange juice. The court held that the orange juice sold to consumers had to be labeled with the foreign country of origin.

In Uniroyal, Inc. v. United States, 542 F. Supp. 1026 (Ct. Int’l. Trade 1982), aff’d. per curiam, 702 F.2d 1022 (Fed. Cir. 1983), the court ruled that a substantial transformation had not occurred when the leather upper portion of a shoe was imported and then attached to the preformed rubber sole in the United States and sold as a “Sperry Topsider.” The court relied heavily on evidence that the time and cost of producing the leather upper in Indonesia were much greater than the time and cost of attaching it to the rubber sole (called a “minor assembly operation”). The court also considered that the fashioning of the leather uppers in Indonesia required far greater skill than was required to attach the sole in the United States. The court stated that “[I]t would be misleading to allow the public to believe that a shoe is made in the United States when the entire upper—which is the very essence of the completed shoe—is made in Indonesia and the only step in the manufacturing process performed in the United States is the attachment of an outsole.” The court noted that unlike the earlier case involving typewriter spools, the upper leather portion of the shoe was not just a vehicle for selling something else, but was the major reason that consumers selected this shoe.

Customs has frequently addressed whether the assembly in one country of component parts made in another country or countries is a substantial transformation. Customs looks at the totality of the circumstances. Typically, it rules that a simple assembly is not a transformation, whereas a “meaningful” assembly is. Customs looks at the nature and number of operations, the time involved, the level of skill, detail and quality control necessary for the assembly, and, to a lesser extent, the number of components. If the assembly leaves the identity of the original item intact, as was the case with the boat shoes, there is no substantial transformation. They will determine if the complete product has a new name, character, and use. In a 2008 determination, Customs considered the assembly in Mexico of ground fault interrupters (like those used in bathroom and kitchens to prevent shock) made from 30 Chinese components, taking 43 steps in 10 minutes. Customs noted that the Chinese printed circuit board was the major functional part, that the circuit board provided the “essential character” to the final product, that all of the components had originated in China, most of the assembly time was devoted to testing, and that the assembly operation was not complex. They entered the U.S. as products of China, not Mexico. Notice of Issuance of Final Determination Concerning Ground Fault Circuit Interrupter, 73 Fed. Reg. 54,420 (Sept. 19, 2008).

Ferrostaal Metals Corp. v. United States illustrates the difficulty of determining whether a substantial transformation has occurred. As this case shows, the precise definition of substantial transformation is unclear because so many factors can be considered. The courts have recognized that it is difficult to take legal concepts applicable to products such as textiles and apply them to combinations of liquids or the fabrication of steel articles. Faced with complex cases, courts have developed rules on a case-by-case basis. The unpredictable nature of these court rulings increases importers’ difficulties in interpreting and applying the rules of origin, as evidenced by the large number of customs cases appealed to the courts.

As you read, consider the actual process of hot-dip galvanizing described here. Would you agree that the operations performed on the steel in New Zealand created a product with a new “name, character, or use”?

North American Preferential Rules.

The North American Free Trade Agreement (NAFTA) eliminates all normal tariffs on goods traded among Canada, Mexico, and the United States, provided that the goods originate in one of those countries. Under the NAFTA rules of origin, goods originate in North America if they are wholly obtained or produced there (or as some writers have said with a little exaggeration and humor, “wholly” means that the goods cannot have “one atom” that did not originate in North America). Goods that are made from materials or components that originated outside North America qualify for free trade status only if each and every non–North American material or component (called inputs) has undergone the change in tariff classification required in NAFTA Annex 401. For example, a product manufactured in Canada from several different raw material inputs originating in Europe can be shipped to the United States as having originated in North America (at the tariff rate applicable to Canadian goods and labeled “Made in Canada”) only if every single one of the European materials or components underwent the change in tariff classification set out in the NAFTA agreement when they were made into the final product in Canada. This is known as the NAFTA tariff shift rule. Automobiles, trucks, and certain other goods are subject to both the tariff-shift and “regional value-content” rules. NAFTA rules can be found in the general notes to the harmonized tariff schedules. See the NAFTA chapter for additional information.

Ferrostaal Metals Corp. v. United States

664 F. Supp. 535 (1987) Court of International Trade

BACKGROUND AND FACTS

Plaintiff attempted to enter steel products at the Port of Seattle. They consisted of unpainted steel sheets that had originated in Japan but had been hot-dip galvanized in New Zealand. Plaintiff’s entry documents identified New Zealand as the country of origin. Customs ruled that the country of origin was Japan and that the steel was therefore subject to a voluntary restraint agreement between the United States and Japan. Customs contended that hot-dip galvanizing of Japanese steel sheets in New Zealand was merely a “finishing process” carried out to improve certain performance characteristics of the steel sheets and not a process that results in a substantial transformation so as to change the country of origin. The plaintiff disagreed and brought this action for review.

JUDGE DICARLO

Substantial transformation is a concept of major importance in administering the customs and trade laws. In addition to its role in identifying the country of origin of imported merchandise for purposes of determining dutiable status, or, as in this case, the applicability of a bilateral trade agreement, substantial transformation is the focus of many cases involving country of origin markings….

The essence of these cases is that a product cannot be said to originate in the country of exportation if it is not manufactured there. The question, therefore, is whether operations performed on products in the country of exportation are of such a substantial nature to justify the conclusion that the resulting product is a manufacture of that country. “Manufacture implies a change, but every change is not manufacture….

There must be transformation; a new and different article must emerge, ‘having a distinctive name, character, or use.’” Anheuser-Busch Brewing Ass’n. v. United States, 207 U.S. 556, 562, 28 S.Ct. 204, 206 (1908). The criteria of name, character, and use continue to determine when substantial transformation has occurred, and the prior cases of this court and our predecessor and appellate courts provide guidance in the application of this test.

* * *

Whether galvanizing and annealing change the character of the merchandise depends on the nature of these operations and their effect on the properties of the materials To produce one of the types of imported sheet… the sheet must be heated to 1,350 degrees F, at which point recrystallization of the grains of steel occurs. The sheet is then brought down to 880 degrees F, before galvanizing begins. At 880 degrees F, the sheet enters a pot of molten zinc and is dipped. The molten zinc reacts immediately with the solid steel, and begins a process known as “alloying.” Alloying constitutes a chemical change in the product, characterized by the formation of iron-zinc alloys at the interface between the steel and the zinc. The galvanized steel sheet emerging from the bath has a mixed zinc-steel surface with an identifiable atomic pattern. The formation of a galvanized surface is an irreversible process which provides electrochemical protection to the sheet. As a result of the galvanic protection, the steel will last up to twenty years, or ten times as long as ungalvanized steel….

The alloy-bonded zinc coating affects the character of the sheet by changing its chemical composition and by providing corrosion resistance. The court also finds that the hot-dip galvanizing process is substantial in terms of the value it adds to full hard cold-rolled steel sheet. The evidence showed that the Japanese product is sold for approximately $350 per ton, while the hot-dipped galvanized product is sold for an average price of $550 to $630.

Taken as a whole, the continuous hot-dip galvanizing process transforms a strong, brittle product which cannot be formed into a durable, corrosion-resistant product which is less hard, but formable for a range of commercial applications. Defendant’s witness stated that the imported sheet has a “different character from the standpoint of durability.” The court finds that the annealing and galvanizing processes result in a change in character by significantly altering the mechanical properties and chemical composition of the steel sheet.

The court also finds substantial changes in the use of the steel sheet as a result of the continuous hot-dip galvanizing process. Testimony at trial overwhelmingly demonstrated that cold-rolled steel is not interchangeable with steel of the type imported, nor are there any significant uses of cold-rolled sheet in place of annealed sheet.

The name criterion is generally considered the least compelling of the factors which will support a finding of substantial transformation. Nonetheless, the satisfaction of the name criterion in this case lends support to plaintiffs’ claim. The witnesses for both parties testified that the processing of full hard cold-rolled steel sheet results in a product which has a different name, continuous hot-dip galvanized steel sheet.

The court also considers relevant whether the operations underlying the asserted transformation have effected a change in the classification of the merchandise under the Tariff Schedules of the United States. Change in tariff classification may be considered as a factor in the substantial transformation analysis. Here this factor supports a substantial transformation. Full hard cold-rolled steel sheet is classified under item 607.83, TSUS, while continuous hot-dip galvanized steel sheet is classifiable under item 608.13, TSUS. (The TSUS was the forerunner to the Harmonized Tariff Schedule.)

Based on the totality of the evidence, showing that the continuous hot-dip galvanizing process effects changes in the name, character, and use of the processed steel sheet, the court holds that the changes constitute a substantial transformation and that hot-dipped galvanized steel sheet is a new and different article of commerce from full hard cold-rolled steel sheet.

Decision. Japanese steel that had been galvanized in New Zealand prior to its importation into the United States was substantially transformed so that it had become a product of New Zealand and thus was not subject to voluntary restraint agreements between the United States and Japan.

Comment. “Voluntary restraint agreements” such as those described in this case to restrict steel imports from Japan are no longer used as a method of limiting imports of foreign goods into America, as they do not fall under the permissible rules of the WTO. Nevertheless, this case serves well to illustrate the use of the substantial transformation test in tariff cases. The case was cited in 2003 by U.S. Customs in a ruling determining the country of origin of fiber optic cable.

Case Questions

1. Why is the process of galvanizing steel important to the court’s decision?

2. Describe the results of the processing that took place in New Zealand.

3. Of the three factors generally referred to—name, character, use—which seem to be the most or least important?

4. What other factors does the court consider in addition to a change in the name, character, and use of the product?

5. Why is the court’s reference to change in tariff classification interesting today?

Other Trade Preference Rules.

The United States grants trade preferences to countries other than NAFTA. Preferences are found in bilateral and multilateral free trade agreements, such as those with Israel, Jordan, Chile, or the Caribbean countries, or in programs such as the Africa Growth and Opportunity Act that gives preferential duty treatment to imports of goods from Africa. Each trade agreement or program has its own rules of origin, including a version of the substantial transformation test. We will cover these later in this chapter.

Coming Changes in Rules of Origin?

In 2008, U.S. Customs announced that it was considering abandoning the judicially made substantial transformation test, like those in the cases we discussed, and moving to the tariff shift rule for all imports. Customs favors this rule because it is more precise and not as subjective as the substantial transformation test. Such a rule would be less subject to misinterpretation, argument, and court action. However, as of this writing, Customs has not implemented the rule.

WTO Agreement on Rules of Origin

Exporters and importers worldwide would benefit greatly from standardized rules of origin, which would let them more accurately determine the country of origin of their shipments in advance. This would help in product labeling as well as in determining the rate of duty and other laws applicable to their products. The WTO Agreement on Rules of Origin (1995) is a long-term project to achieve this goal. As of this writing, the WTO was in the process of developing new, uniform rules. These rules will apply to all trade between countries that are members of the WTO. Under the proposed rules, the country of origin would be determined by a tariff shift rule, similar to that used in the NAFTA agreement.

Special Rules of Origin for Textiles and Apparel

The world’s textile and apparel industry operates on a global scale. Textile firms shift the site of spinning, weaving, cutting, sewing, and other operations from country to country and from region to region to take advantage of low-cost labor and materials and to benefit from customs and tariff laws in the country in which the goods will be sold. For instance, cotton might be grown and spun into yarn in China, where it is woven into cloth. The cloth might be sent to Hong Kong, where it is cut to form pieces of garments (e.g., sleeves, collars, etc.), and then sent to Honduras for assembly. Textile and apparel manufacturers must consider the rules of origin in sourcing yarn, fabric, and other raw materials or in locating textile dyeing and finishing operations, cut-and-sew plants, or assembly operations.

Textile and apparel imports in the United States are governed by specialized rules of origin. (Textiles sold in North American follow NAFTA rules of origin.) Textile rules are more complex and arcane than rules applicable to other products, which makes it more difficult for firms to import textiles than almost any other product. Many factors determine the country of origin of textile and apparel products: the type of product (e.g., yarn, fabric, clothing and apparel, or textile products for the home), the fiber content (e.g., silk, wool, or cotton), and the steps or processes that take place in the transition from yarn to fabric to final product. The administrative rules of origin for textile and apparel products promulgated by U.S. Customs can be found in 19 CFR 102.21.

Here are a few generalizations: Many textile products are covered by tariff shift rules, under which the country of origin is determined by whether or not the operation (weaving, cutting, assembly, or whatever) causes a specified shift in the tariff classification of a raw material. The country of origin of certain items, including many home textile products, is often the country where the fabric was formed by weaving or some other fabric-making process, regardless of where it was cut and assembled into a finished product. Products that are knitted to shape, such as hosiery, socks, knitted gloves, and mittens, generally originate in the country in which they were knitted. Some articles, such as clothing and apparel, originate in the country where they were wholly assembled, or if none, where the most important assembly or manufacturing process took place. Other items are said to have originated where the fabric from which they were made was dyed and printed (when combined with two or more finishing operations), rather than where they were woven. Cutting fabric into pieces, without more, is not enough to confer country of origin status. Clearly, anyone determining the country of origin of a textile product must understand textile production processes and be able to accurately trace all steps of global operations from beginning to end. Critics of the rules of origin point out that there is no logical method to the rules and many commentators believe they derive primarily from political considerations.

These contradictory and confusing rules often stymie the most experienced importers. So, textile and apparel manufacturers and importers rely heavily on attorneys and customs brokers that specialize in textile imports. They also frequently obtain binding ruling letters from U.S. Customs in advance of setting up operations to be certain that they comply with the law.

Opportunities for Business Planning.

The rules of origin can provide a resourceful importer with significant opportunities for good business planning. With proper legal advice, a firm can structure its global operations to minimize tariffs and take advantage of the favorable trade and tariff treatment granted to goods coming from particular foreign countries. After all, trade and tariff laws are designed in part to either encourage or discourage trade with particular nations. Many firms, particularly multinational corporations, are therefore capable of shifting global resources and production facilities to those countries whose goods receive the most favorable trade and tariff treatment in the United States or other major importing nations. But to do this, the corporation must follow the importing nation’s rules of origin meticulously. The tariff savings can be so great that some unscrupulous U.S. importers have been tempted to transship articles through developing countries, repackage or relabel them, and then enter them into the United States at the lower tariff rate. The penalties for furnishing false information to U.S. Customs authorities are quite severe.

Marking and Labeling of Imports

The United States has two key laws that require imports to be labeled with the country of origin: the marking rules of U.S. Customs and the Federal Trade Commission (FTC) rules. The rules of U.S. Customs apply to country of origin markings of all imported products sold in the United States. The FTC rules apply primarily to the use of “Made in U.S.A.” or similar terms. To be labeled “Made in U.S.A.,” a label must meet the requirements of both agencies.

Customs Marking Rules.

Every article of foreign origin imported into the United States must be indelibly and permanently marked in English in a conspicuous place and in such a manner as to indicate the name of the country of origin of the article to the ultimate purchaser in the United States. The ultimate purchaser is the last person in the United States who receives an article in the form in which it was imported. If an imported article is to be sold at retail in the same form as it was imported, then the retail customer is the “ultimate purchaser.”

If the imported article is converted, processed, or combined with other articles or ingredients in the United States so that it undergoes a substantial transformation resulting in a new article of commerce with a new name, character, or use, as defined by the Gibson-Thomsen case, then the U.S. firm that transformed the article is considered the ultimate purchaser. As a result, the new product need not be labeled with a foreign country of origin.

Does that mean that it can be labeled “Made in U.S.A.”? Perhaps not. As we will see in the next section, the FTC rules take precedence, and they will not allow that claim unless the new product is “all or virtually all” made in America. Because the product was only “transformed” in the United States from foreign materials, it might be labeled “Made in U.S.A. of Imported Materials.”

Items Not Requiring Marks.

Customs regulations specify many articles by name that are exempt from marking requirements. These are generally objects that are incapable of being marked because of their size or special characteristics. Examples include works of art, unstrung beads, rags, nuts, bolts, screws, cigarettes, eggs, feathers, flowers, cellophane sheets, livestock, bamboo poles, maple sugar, vegetables, and newsprint. In addition, the following general exemptions exist for certain categories of products: (1) products incapable of being marked; (2) products that cannot be marked without injury; (3) crude substances; (4) articles produced more than twenty years prior to importation; (5) products of possessions of the United States; (6) articles imported solely for the use of the importer and not intended for resale (e.g., personal articles purchased abroad by a tourist); (7) products of American fisheries that are entered duty-free; and (8) certain products of the United States that are exported and returned. In addition, articles used by an importer as samples in soliciting orders and that are not for sale are exempted from the marking requirements.

When an item is exempt from marking requirements, the container in which it is sold to the consumer must be marked. To illustrate, imported carpentry nails need not be marked, but the box in which they are sold to the consumer must be.

Federal Trade Commission “Made in U.S.A.” Rules

In the United States, the FTC and U.S. Customs have overlapping jurisdiction with regard to country of origin claims. While Customs oversees foreign country of origin marking (“Made in China”), the FTC regulates the use of the term “Made in U.S.A.” Customs rules apply only to product marking, whereas the FTC rules apply to all claims, including those on product labels, catalogs, packaging, and all forms of advertising. Customs rules are more complex and detailed, whereas the “Made in U.S.A.” rules of the FTC are more flexible and are based on whether or not the claims would mislead or cause deception in the minds of the average consumer. The FTC bases its rules on its authority under the Federal Trade Commission Act to prevent unfair or deceptive trade practices.

There is no rule that requires a U.S.-made product to be labeled as such. Except for special rules applicable to automobiles and textile and fur products, U.S. content need not be disclosed. However, a seller may not claim that a product is “Made in U.S.A.” unless all or virtually all of the materials, processing, or component parts are made in the United States and their final assembly or processing took place there. All significant parts and processing that go into the product must be of U.S. origin. That is, the product should contain only negligible foreign content. For instance, the FTC has held that a gas barbecue grill assembled entirely from U.S. parts could be labeled as “Made in U.S.A.” despite the fact that the knobs were of foreign origin. The knobs were said to make up a small portion of the product’s total cost and an insignificant part of the final product.

The FTC origin rules apply also to other more indirect forms of marketing and promotion that may be deceptive. In one case, a company packaged its Chinese-made product in a package covered with an American flag and eagle. Despite the statement “Made in China,” which appeared in small print on the bottom and side panels of the package, the FTC held that the labeling was deceptive.

Partly Made in the U.S.A.?

Products that cannot be labeled as “Made in U.S.A.” may still bear qualified claims. A qualified claim is one that indicates that the product was partially made or processed in the United States. An example would be a down comforter labeled “Shell made in Germany with filling and further processing in the U.S.A.” To use a qualified claim, there must still be a significant amount of U.S. content. A product that is invented in the United States and made in India could not claim “Created in U.S.A.,” as this would be deceptive. The term “Assembled in U.S.A.” may be used only where the product has undergone a substantial transformation in the United States and where the use of the term would not be deceptive. For example, according to the FTC, component parts for computers made in Singapore and assembled in Texas with only a screwdriver and screws may not be labeled as “Assembled in U.S.A.” Here there was no substantial transformation in the United States and the statement is deceptive.

U.S. TRADE PREFERENCES FOR DEVELOPING COUNTRIES

Trade preferences, such as reduced tariffs or duty free status, are granted to developing countries to help further their social and economic development. Most developed nations, including the United States, Canada, Japan, and the European Union, grant trade preferences to developing countries, not only in their own hemispheres but also around the world. Four important U.S. programs for developing countries are the Generalized System of Preferences, the Caribbean Basin Initiative, the African Growth and Opportunity Act, and the Andean Trade Preference Act.

The Generalized System of Preferences

Under the Generalized System of Preferences (GSP), the United States aids in the economic development of certain developing countries by allowing their products to enter the United States at reduced rates of duty, or duty-free, until such time as these countries establish their own competitive industries. Such a trade preference is allowed under the terms of GATT and is similar to programs that other industrialized nations offer developing countries (notably the preferences granted by European nations to the products of many African nations). The program was begun in the United States in 1976 and has been renewed regularly by Congress. Mexico no longer qualified for the GSP when it joined NAFTA in 1994. There are approximately 130 countries eligible for GSP status. In 2009, imports worth over $20 billion entered the United States duty-free under the GSP.

Eligibility for GSP Status.

In order for a country to be eligible for GSP status, it must be designated a beneficiary developing country. Countries are not eligible for GSP status if they (1) have participated in an organized embargo of oil against the United States, (2) do not cooperate with the United States in the enforcement of narcotics laws, (3) aid and abet international terrorism, (4) have unlawfully expropriated the property of U.S. citizens, (5) do not recognize or enforce the arbitral awards of U.S. citizens, or (6) are controlled by communist governments. In addition, the president has wide authority under the GSP statute to deny duty-free treatment on political and economic grounds. For instance, the president can deny GSP status to any country that does not protect the patents, trademarks, and copyrights of U.S. citizens; maintains unreasonable restrictions on U.S. investment; does not grant internationally recognized worker rights to its workers; or whose exports to the United States injure a U.S. industry.

The product must also be eligible for duty-free treatment; about 5,000 types of products are eligible. Many of the eligible products are agricultural. A few examples of typical products admitted under the GSP include sugar, jewelry, leather shoe uppers, wooden furniture, Christmas tree lighting, and telephones. Certain importsensitive products, such as textiles, footwear, steel, watches, and some electronic items, are not eligible.

A country may lose GSP benefits for specific products under competitive need limits. Competitive need is determined by an annual review process conducted on a product-by-product basis. Usually the duty-free status of a country’s product will be terminated when more than half of the total U.S. imports of that product are imported from one GSP country or when imports of that product from the GSP country exceed a dollar level established by Congress. Competitive need limits do not apply to sub-Saharan Africa. U.S. firms, labor unions, and even foreign governments may petition that products be added to or removed from the GSP list.

Once a developing country reaches a per capita gross national product of $8,500, it becomes ineligible for GSP treatment and is considered to have graduated. By the close of the 1980s, the four “Asian tigers” of Hong Kong, Singapore, South Korea, and Taiwan had graduated from the GSP.

GSP Rules of Origin.

In order for an article to qualify for duty-free treatment, it must meet the following requirements: (1) it must be imported into the United States directly from the beneficiary developing country; (2) it must be the “growth, product, or manufacture” of the beneficiary developing country (or substantially transformed there into a product with a new name, character, and use); and (3) at least 35 percent of the value of materials and the direct cost of processing operations must have been added to the article in a single beneficiary developing country (or in any two or more GSP countries that are members of the same free trade association, such as ASEAN, CARICOM, or the Andean Group). A special rule applies when raw materials are brought to the GSP country from another country and then made into a finished article and shipped to the United States. In this case, the law requires a dual transformation. The raw materials brought from another country into the GSP country must first undergo a substantial transformation in the GSP country, resulting in a new and different article of commerce, in order for that article to be included in the 35 percent value content requirement. Then that article must undergo a second transformation into another new and different article of commerce, which is then shipped to the United States.

To better illustrate, consider the following example of a dual transformation adapted from the Code of Federal Regulations:

A raw, perishable skin of an animal grown in a nonbeneficiary country is sent to a beneficiary country where it is tanned to create nonperishable leather. The tanned leather is then cut, sewn, and assembled with a metal buckle imported from a nonbeneficiary country to create a finished belt that is imported directly into the United States. Because the operations performed in the beneficiary country involved both the substantial transformation of the raw skin into a new or different article (tanned leather) and the use of that intermediate article in the production or manufacture of a new or different article imported into the United States, the cost or value of the tanned leather used to make the imported article may be counted toward the 35 percent value requirement. The cost or value of the metal buckle imported into the beneficiary country may not be counted toward the 35 percent value requirement because the buckle was not substantially transformed in the beneficiary country into a new or different article prior to its incorporation in the finished belt.

Caribbean Basin Initiative

America’s leading imports from the Caribbean include petroleum products, chemicals, natural gas, textiles and apparel, agricultural products such as coffee and tropical fruits, electrical parts, and many others. According to the U.S. Department of Commerce, total U.S. imports from the Caribbean in 2008 were about $19.6 billion. The Caribbean Basin Initiative (CBI) is the name collectively given to several laws that grant trade preferences to aid the Caribbean countries. These are the Caribbean Basin Economic Recovery Act, the Caribbean Basin Trade Partnership Act, and the Haitian Hemispheric Opportunity through Partnership Encouragement Act (the HOPE Act). These give the president the authority to grant tariff reductions or duty-free status to imports from eligible countries in order to encourage trade and investment in the Caribbean. The CBI countries, as of 2007, were those shown in Exhibit 12.5. A few of the other products benefiting from the preferences are cigars, cane sugar, communications equipment, electrical and non-electrical machinery, medical appliances, orange juice, bananas, ethyl alcohol, baseballs, and rum.

Exhibit 12.5: Caribbean Basin Beneficiary Countries (2010)

Antigua and Barbuda

Aruba

Bahamas

Barbados

Belize

British Virgin Islands

Dominica

Grenada

Guyana

Haiti

Jamaica

Montserrat

Netherlands Antilles

Panama

St. Kitts & Nevis

St. Lucia

St. Vincent & the Grenadines

Trinidad & Tobago

Many CBI countries, but not all, also qualify for benefits under the GSP. However, the criteria are not the same for product eligibility. Unlike the GSP, the Caribbean program has no provisions for graduating Caribbean countries on the basis of any economic criteria. The CBI applies to a greater variety of products than the GSP, and the competitive need requirements of the GSP are not applicable. This is a permanent program with no expiration date. However, the president must certify that each eligible country is recognizing the rights of workers to collective bargaining; eliminating child labor abuses; setting a minimum age for employing children; setting an acceptable minimum wage; and establishing acceptable hours of work and occupational safety and health standards.

Caribbean Rules of Origin.

Caribbean preference rules of origin are similar to those of the GSP. In addition, Caribbean preferences include duty-free entry into the United States for articles that have been “assembled or processed” in eligible countries from U.S.-made “components, materials, or ingredients.” In other words, U.S.-made parts may be subjected to minor assembly, finishing, and processing operations in a Caribbean country, and then shipped back to the United States for duty-free entry. For these products, the substantial transformation requirement has been eliminated.

Africa Growth and Opportunity Act

The Africa Growth and Opportunity Act (AGOA) was intended to aid in the economic growth and the establishment of political freedom in forty-eight poor countries in sub-Saharan Africa where the per capita annual income averages about $500 per year. The law encourages U.S. trade and investment there and improves access for African products to U.S. markets. To qualify for the benefits of the act, the African countries must try to improve their own conditions through progressive economic and social policies. The country must abide by human rights standards, eliminate abuses of child labor, and not support terrorism. Forty-seven countries are now eligible. AGOA grants preferences even more favorable than the GSP. It includes duty-free status for 6,500 eligible products. The largest AGOA sectors are petroleum, minerals (including platinum and diamonds), motor vehicle parts, steel, textiles, jewelry, fruit and nuts, leather, and cocoa. U.S. imports of AGOA products in 2008 totaled over $86 billion. About 60 percent of these came from Nigeria and Angola.

In order to qualify for AGOA preferences, an article must be produced or manufactured in an AGOA country and meet the rules of origin. For most products, the rules are similar to, but more lenient than, the GSP rules with which you are already familiar. African-made apparel generally qualifies for duty-free treatment if it is made from African-or U.S.-made fabric that was woven from U.S.-made yarn and assembled with U.S.-made thread or made from fabrics in short supply (linen, silk, batiste, velveteen, and some others).

U.S.-Andean Trade

The Andean Trade Preference Act program is part of an effort by the United States to promote economic development in the Andean countries while combating drug trafficking and encouraging democracy. The countries currently receiving benefits are Peru, Colombia, and Ecuador (Bolivia was removed in 2009), and their major exports are natural gas, minerals, certain metal products (copper, zinc, etc.), jewelry, forest and wood products, coffee, cocoa, fruits and vegetables, cut flowers, sugar, handicrafts, leather accessories, footwear, and textile products, to name a few. The program permits the duty-free import of almost 6,000 different kinds of products into the United States. The program was renewed by the U.S. Congress in the Andean Trade Promotion and Drug Eradication Act of 2002. In 2009, U.S. firms exported $16.7 billion to the three countries, invested $16.1 billion there, and imported over $21 billion in Andean goods covered by the program.

There is a movement toward supplanting the Andean trade preference program with a U.S.-Andean free trade agreement. The trade agreement would require that the Andean countries open their markets to U.S. goods, a notion not always popular in South America. Also, a free trade agreement would cover other topics, such as intellectual property, government procurement, the environment, labor issues, and dispute settlement. As of 2010, the United States-Peru Trade Promotion Agreement was already in effect. A similar agreement was negotiated with Columbia, but not yet passed by Congress because of the recent murders of labor organizers and civil rights violations in Columbia.

United States-Central America-Dominican Republic Free Trade Agreement

In 2005, the United States entered into a free trade agreement known as CAFTA-DR with Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the island nation of the Dominican Republic. Unlike the GSP and other programs just mentioned, CAFTA-DR is not a trade preference program, but a free trade agreement based on reciprocity and mutual agreement. According to the U.S. Department of Commerce, the agreement will result in duty-free status for over 80 percent of U.S. goods shipped there, with remaining tariffs phased out over five to ten years (fifteen years for agricultural products). The agreement also addresses many collateral issues, such as corruption, labor standards, environmental protection, and the protection of intellectual property. CAFTA-DR has its own rules of origin. In 2009, the U.S. imported $18.8 billion worth of products from CAFTA-DR countries, while exporting $19.9 billion to them.

OTHER CUSTOMS LAWS AFFECTING U.S. IMPORTS

This section examines two other laws affecting U.S. imports: drawback provisions allowing a refund of duties paid, and foreign trade zones.

Drawbacks

A drawback is a refund of duties already paid. The most common type is the manufacturing drawback, designed to encourage U.S. manufacturers to export. A manufacturing drawback is a 99 percent refund of duties and taxes paid on merchandise that is imported, subjected to manufacture or production, and then exported within five years. U.S. firms are becoming increasingly sophisticated in using manufacturing drawbacks. For instance, duties paid on imported yarn will be refunded to the importer who exports a finished fabric made from that yarn. Similarly, a poultry farm that imports chicken feed can receive a drawback on duties paid on the imported feed when the chickens are slaughtered and exported. Drawbacks such as these allow the exporter to purchase materials from low-cost foreign suppliers, including non-MFN countries, without having to pay prohibitively high duties. The use of drawbacks in U.S.-Canadian trade was eliminated in 1996. In U.S.-Mexican trade, drawbacks have also been eliminated.

Same-condition drawbacks are utilized when the imported goods are not processed or manufactured, but are reexported in the “same condition” as they were imported. These products are not significantly altered while in the United States (although they may be repackaged, cleaned, tested, or displayed). For example, nuts and bolts can be entered in bulk and sorted and repackaged in packages with foreign-language labeling. On export, the drawback applies. Many trading companies utilize same-condition drawbacks.

In certain cases, an importer may export U.S.-made goods in the substitution of imported goods that are of the “same kind and quality” (i.e., interchangeable) and receive the drawback on the imported items. This practice is known as a substitution drawback. In most instances, these substitution drawbacks deal with fungible goods or commodities such as agricultural products. Substitution drawbacks are applicable to both manufacturing and same-condition drawback situations. For instance, assume that a U.S. manufacturer imports semiconductors for use in making computers. The manufacturer may receive a drawback on duties paid if it exports, within three years, products containing U.S.-made semiconductors of the same kind and quality. If the company exports only 40 percent of its production, it can claim a drawback for 40 percent of the duties paid (a manufacturing/substitution situation). To take another example, the importer of soda ash can decide to resell the foreign soda ash in this country and export the same quantity of U.S.-made soda ash to a foreign buyer; the importer then can receive a drawback on duties paid on the imported soda ash (a same-condition/substitution situation).

A drawback of 99 percent is also allowed for imported merchandise that does not conform to specifications or to samples (e.g., zippers that do not zip; receipt of cotton sweaters instead of wool), provided that the error was the fault of the foreign shipper (not the importer) and the merchandise is returned to U.S. Customs within ninety days for inspection and returned to the seller under Customs supervision. A similar drawback is allowed for merchandise shipped to a U.S. firm without its consent. If a U.S. firm imports foreign goods and finds that they are useless and cannot be returned, the importer can receive a drawback on the duties paid on the merchandise, which is subsequently destroyed.

A drawback is essentially a contract with U.S. Customs. Firms wishing to arrange a drawback need competent advice in doing so. The procedures, time limits, documentation, and accounting requirements for obtaining all drawbacks are complex and exact, and many U.S. companies use the services of specialist firms for advice on structuring drawback transactions. Some firms utilize specially developed software to help track and document a drawback transaction. Civil penalties are imposed for violating the provisions of the law. Many firms do not file for drawbacks for fear of being assessed a penalty for clerical errors. The criminal penalties for fraudulently claiming a drawback are severe.

Foreign Trade Zones

Foreign trade zones (FTZs) are legally defined sites within a country that are subject to special customs procedures. They are monitored by, and under the control of, the customs authorities of that country. Foreign trade zones exist under the laws of most nations, including the United States. In the United States, FTZs operate under a license from the Foreign Trade Zone Board and according to regulations of the board and of U.S. Customs and Border Protection. Foreign trade zones must be within a 60-mile radius of a U.S. port of entry. Imported goods may be brought into an FTZ without being subjected to tariffs until such time as the goods are released into the stream of commerce in the United States.

FTZs are operated by state or local governments, airports or seaports, or specially chartered corporations who charge private firms for their use. Originally, FTZs were intended to encourage U.S. firms to participate in international trade by providing a “free port” into which foreign-made goods could be transported, stored, packaged, and then reexported without the payment of import duties. Today, FTZs are used for many different purposes, ranging from warehousing to manufacturing. Goods may be assembled, exhibited, cleaned, manipulated, manufactured, mixed, processed, relabeled, repackaged, repaired, salvaged, sampled, stored, tested, displayed, and destroyed. Manufacturing may result in a change to the tariff classification of the goods only with permission of U.S. Customs. Retail sales are prohibited. The length of time that these goods can be held in a zone is not limited.

The flexibility offered to an importer through the use of FTZs provides many opportunities for creative importing strategies. For example, firms can ship goods to their zone duty-free and hold them for later entry and sale in the United States pending buyer’s orders or more favorable market conditions. Foreign goods can also be held for exhibition and display in the zone for unlimited periods without the payment of duties. Foreign goods that arrive damaged or defective may be destroyed without the payment of duties. Goods in an FTZ are not subject to quotas and may remain in the FTZ until the quota opens and their entry is permitted. Title to goods held in an FTZ may be transferred to another party without the payment of duties (although not to a retail customer for consumption outside of the FTZ). Opportunities for creative business planning are almost endless. For instance, in certain cases it is possible that foreign component parts can be assembled in an FTZ, making the duties payable when the finished product is sold less than what the duties would have been on the individual components. As another example, if a commodity is dutied by weight, it may be brought into an FTZ for drying; subsequently it may be entered without the excess weight caused by the moisture. But perhaps the most unusual use of an FTZ is the Cape Canaveral Zone in Florida. There, foreign payloads can be imported into the United States, processed and made ready for a space launch, and “exported” to space without the payment of U.S. import duties! Over two hundred general purpose foreign trade zones and more than two hundred and fifty subzones exist in the United States.

In addition to general purpose zones, firms are able to establish their own special purpose subzones. Subzones can be placed anywhere in the United States with U.S. Customs approval. Most automotive manufacturers and oil refineries use subzones. They are also widely used in chemicals, pharmaceuticals, computer assembly, electronics, and shipbuilding and as retail distribution centers. The following case, Nissan Motor Mfg. Corp. U.S.A. v. United States, arose out of Nissan’s importation of equipment into an automotive manufacturing subzone in Tennessee.

Nissan Motor Mfg. Corp., U.S.A. v. United States

884 F.2d 1375 (1989) United States Court of Appeals (Fed. Cir.)

BACKGROUND AND FACTS

Nissan operates a foreign trade zone subzone at its automotive manufacturing and assembly plant located in Smyrna, Tennessee. Nissan imported production machinery for use in the subzone consisting of industrial robots, automated conveyor systems, and a computerized interface. The machinery was to be assembled and tested in the zone, and if it proved unsatisfactory it was to be replaced, redesigned, or scrapped. Customs ruled that production equipment was not “merchandise” as defined under the FTZ act and was therefore dutiable. Duties were liquidated at $3 million and Nissan filed a protest. On denial, the Court of International Trade ruled that the equipment was dutiable, and this appeal was filed.

CIRCUIT JUDGE ARCHER

The activities performed by Nissan in the foreign trade zone subzone with the imported equipment are not among those permitted by a plain reading of the statute. Section 81c provides that merchandise brought into a foreign trade zone may be “stored, sold, exhibited, broken up, repacked, assembled, distributed, sorted, graded, cleaned, mixed with foreign or domestic merchandise, or otherwise manipulated, or be manufactured….”

The act does not say that imported equipment may be “installed,” “used,” “operated” or “consumed” in the zone, which are the kinds of operations Nissan performs in the zone with the subject equipment. Alternative operations of a different character should not be implied when Congress has made so exhaustive a list.

Nissan relies upon the case of Hawaiian Indep. Refinery v. United States, 460 F. Supp. 1249 (Cust. Ct. 1978), in support of its position. The merchandise there involved was crude oil which was entered into a foreign trade zone for manufacture into fuel oil products. This, of course, is an activity delineated by the act and entry into the zone was exempted from Customs duties. Thereafter, a portion of the crude oil was consumed in the manufacturing process and Customs assessed duty on the theory that there had been a “constructive” entry into the Customs territory of the United States. In holding that the assessment was improper, the Court of International Trade did not have to deal with the question at issue here of whether the initial entry into the zone was exempt. Clearly, in that case the crude oil was exempt at the time of entry. Thus, the Court of International Trade properly concluded that the Hawaiian Indep. Refinery case was not dispositive of this case.

We are convinced that the Court of International Trade correctly determined that the importation by Nissan of the machinery and capital equipment at issue into the foreign trade zone subzone was not for the purpose of being manipulated in one of the ways prescribed by the statute. Instead it was to be used (consumed) in the subzone for the production of motor vehicles. Under the plain language of the 1950 amendment to the act and the legislative history of that amendment, and Customs’ published decision interpreting the act as amended, such a use does not entitle the equipment to exemption from Customs duties. Accordingly, the judgment of the Court of International Trade is affirmed.

Decision. The decision of the lower court was affirmed. Machinery entered into a foreign trade zone for use in the manufacture and assembly of automobiles is not “merchandise” under the act and may not be entered duty-free.

Case Questions

1. What purposes do FTZs serve? Why did Congress establish them?

2. What were the advantages to Nissan by assembling automobiles in an FTZ? How many can you list?

3. Why could Nissan not bring manufacturing equipment into its zone duty-free? Do you think this case applies to office chairs or personal computers?

4. Assume that you import merchandise subject to annual quotas. You have a shipment arriving, but the quota has filled. How might an FTZ help you?

5. What FTZs are located in your state or region?

CONCLUSION

The Bureau of Customs and Border Protection is responsible for securing America’s borders from terrorist threat; interdicting illegal immigration, contraband, and narcotics smuggling collecting tariff revenue; enforcing the customs and tariff laws of the United States; and enforcing the export control laws. The importance of the agency has changed in recent years and will continue to grow as Americans focus more on the issue of illegal immigration, as the terrorist threat continues, and as increases in international trade result in greater amounts of cargo arriving at U.S. ports.

U.S. Customs recognizes its enforcement predicament: it must protect the borders of the United States while considering the needs of American importers and exporters for expedited customs entry and delivery and the impact of cargo delays on the U.S. economy. Given the numbers of ocean containers and international flights arriving at U.S. ports every day, most Americans recognize the immense job the agency has been given. They also recognize that the effective and efficient enforcement of the customs laws and the movement of cargo are largely dependent on their cooperation and partnership with customs officials.

All businesspeople must be concerned about complying with the customs and tariff laws of the countries in which they import or export. In the United States, as in other countries, enforcement actions and penalties for violations can be severe. Individuals and firms must adhere to the concept of informed compliance. This means that importers and exporters must use reasonable care in handling entries and must either be adequately trained or rely on trained professionals.

Finally, customs compliance does not mean that importers should not plan their business strategies to take advantage of opportunities in the customs and tariff laws. To the contrary, tariff laws, like many other types of tax laws, are intended to encourage and reward certain business decisions. Multinational companies that structure their global operations to take advantage of incentives in the customs or tariff laws or that source materials and products made in certain countries that have tariff preferences under U.S. law, for example, are simply taking advantage of business opportunities legally provided by Congress. Customs laws will affect where multinationals build their plants, where they source their materials or component parts, how they move goods from country to country, and how they structure their overall global operations. Careful customs planning is essential to the success of any international business plan.

Chapter Summary

1. A formal entry is the administrative process required to import goods into the customs territory of a country. The goods may be entered by the owner, purchaser, consignee (the party to whom the goods are shipped or to be delivered), or a licensed customs broker.

2. The Customs Modernization and Informed Compliance Act introduced the doctrine of informed compliance, which shifted a major responsibility to comply with all customs laws and regulations to the importer. It requires that importers use reasonable care in complying with the law, in handling all import transactions, and in preparing all documentation for entered goods. Reasonable care means more than simply being careful. It means that those handling import transactions must be properly trained, that companies must establish internal controls over import operations to ensure compliance, and that professional advice must be sought when needed.

3. Binding rulings from the Customs Service are an important tool in properly and safely planning import transactions in advance.

4. Most trading nations of the world utilize the schedules of the Harmonized Commodity Description and Coding System for classifying products. In the United States, the Harmonized Tariff Schedule is a federal statute that schedules virtually all goods sold in commerce and lists the tariff rate for each according to the country of origin.

5. Tariffs, restraints on imports, and other import controls are applied to goods according to their dutiable status. The dutiable status of goods is determined by the classification of the article, the transaction value of the article, and the country of origin of the article.

6. Goods are classified in the Harmonized Tariff Schedule either by name, by description of the article’s physical characteristics, by a description of their component parts, or by a description of the article’s use. Goods classified by name are defined by the common or popular meaning of the name, unless it is clear that Congress had intended the commercial or scientific name to apply. Anyone attempting to research the classification of an article in the HTSUS must follow the rules set out in the General Rules of Interpretation. Where an article may be classified under more than one heading, it must be classified under the one that most specifically describes the item. If two or more headings each describe only certain materials or components of the article, the article must be classified under the heading that describes those materials or components that give the article its essential character.

7. The dutiable value of the goods is the transaction value. This is the cost of the goods, adjusted for certain elements of cost set out in the statutes and regulations such as packing costs, assists, or royalty fees.

8. Rules of origin are the national laws and regulations of administrative agencies, usually customs authorities, which are used to determine the country of origin of imported products. There are few areas of customs law that are so complex and that are as difficult for importers to understand. One of the reasons for the complexity is that there are so many different rules applicable to imports from different countries. The general rule is that the country of origin of an imported article is that country where it was wholly and completely produced, manufactured, or obtained entirely from raw materials originating in that country. Where goods are not wholly the product of one country, such as goods assembled in more than one country, importers must rely on the substantial transformation test or tariff shift rules set out in the customs statutes and regulations.

9. Tariff preferences are laws that grant lower tariff rates on products imported from certain countries or regions. The most common tariff preference programs in the United States are the Generalized System of Preferences for developing countries, and regional programs for imports from the Caribbean, Africa, and the Andean region. Europe and other developed countries also have similar tariff preference programs.

Key Terms

importing 364

ports of entry 364

customs broker 365

formal entry 365

informal entry 368

liquidation 368

notice of adjustment 368

deemed liquidation 368

enforced compliance 372

informed compliance 372

binding ruling 374

dutiable status 375

harmonized tariff schedule 377

general rate of duty 378

special rate of duty 378

General Rules of Interpretation 383

rule of relative specificity 384

essential character test 384

tariff engineering 385

dutiable value 387

transaction value 387

production assist 388

contract manufacturing 388

rules of origin 389

country of origin 389

trade preference 389

substantial transformation 390

name, character, or use test 391

tariff shift rule 394

ultimate purchaser 395

Generalized System of Preferences 397

beneficiary developing country 397

competitive need 397

dual transformation 398

manufacturing drawback 399

same-condition drawback 400

substitution drawback 400

foreign trade zone 400

fair trade 406

Questions and Case Problems

1. Visit the Website of the Bureau of Customs and Border Protection. What resources does it contain for the trade community?

a. The Customs Rulings Online Search System (CROSS) is a searchable database of about 100,000 ruling letters. Try your hand at locating rulings on some of the issues discussed in this chapter. For example, enter “country of origin” together with the name of a product or class of products and see what you can find. Remember, these letters are binding only for the individual to whom they are written and only for that transaction. Nevertheless, they are interesting and helpful to importers that use this service frequently.

b. Go to the “Legal” section of the Website and look at the Customs Bulletins and Decisions. This is a weekly diary of all official acts of the agency. What type of information does it contain, and who might want to follow this on a regular basis?

c. Go to the Import section and look at the Container Security Initiative. Six million ocean containers enter U.S. ports every year. Only a tiny fraction can be inspected by hand. Any one of them could be used to hide a weapon of mass destruction. Look at the Customs-Trade Partnership Against Terrorism (C-TPAT), a process for enhancing security between U.S. importers and their foreign supply chains. How do you think the threat of terrorism and Customs’ security programs will affect global transportation in the years to come? What is Customs’ “24-hour rule” for loading cargo aboard ships destined for the United States?

2. Acquaint yourself with the Harmonized Tariff Schedules of the United States. Be sure that you understand how products and commodities are arranged in the schedules and that you know how to use the schedules. The schedules are maintained by the U.S. International Trade Commission and can be found at their Website or through a link on the Customs site. Be sure to find the full text of the law, which is arranged by chapter. (The schedules will appear in a pop-up box using PDF format files.)

a. Know how to use the General Rules of Interpretation and the General Notes.

b. Which countries receive GSP tariff preference treatment?

c. Which countries qualify for duty-free treatment as “least developed beneficiary developing countries?”

d. Which countries qualify for the Andean Trade Preference Act? The African Growth and Opportunity Act preferences?

e. A good portion of the HTSUS is devoted to the dutiable status of goods moving in North America. NAFTA is the subject of the next chapter. Can you locate the NAFTA rules of origin, known as the “tariff shift” rules, in the schedules?

f. Choose several products with which you are familiar, and attempt to classify them using the schedules.

3. The primary body of U.S. customs law is found in Title 19 of the United States Code. The regulations are found in the Code of Federal Regulations. You can access the CFR either through the Web site of the U.S. Customs and Border Protection (“Legal” section) or through the Government Printing Office site. Can you find Customs’ record-keeping rules? What are the rules for filing a protest with U.S. Customs? Can you find the rules of origin, including those for textile imports?

4. Inner Secrets entered 2,000 dozen boxer-style shorts from Hong Kong. The boxer shorts were made of cotton flannel in a plaid pattern, with a waistband that was not enclosed or turned over, a side length of 17 inches, and two small nonfunctional buttons on the waistband above the fly. Two seams were sewn horizontally across the fly, dividing the fly opening into thirds. The boxers did not have belt loops, inner or outer pockets or pouches, or button or zipper fly closures. They were marketed under the label “No Excuses.” Customs classified the garments as outerwear shorts under HTSUS 6204.62.4055: “Women’s or girls’ suits, ensembles, suit-type jackets and blazers, dresses, skirts, divided skirts, trousers, bib and brace overalls, breeches and shorts…. Trousers, bib and brace overalls, breeches and shorts… of cotton… 17.7%.” The Customs Service based its decision on its determination that the boxers will be worn by women as outer clothing. Inner Secrets maintains that the items are not outerwear, as Customs claims, but are actually underwear properly classified under HTSUS 6208.91.3010: “Women’s or girls’ singlets and other undershirts, slips, petticoats, briefs, panties, nightdresses, pajamas, negligees, bathrobes, dressing gowns and similar articles… of cotton… 11.9%.” Inner Secrets filed a protest with the agency, which was denied. Inner Secrets brought this action with the Court of International Trade. What is the proper classification of the boxers? How would a camisole worn under a sport jacket or a slip worn as a dress be classified? Inner Secrets v. United States, 885 F. Supp. 248 (Ct. Int’l. Trade 1995). See also St. Eve International v. United States, 267 F. Supp. 1371 (Ct. Int’l. Trade 2003).

5. Sports Graphics imported soft-sided “Chill” coolers from Taiwan. The coolers consisted of an outer shell of a vinyl-coated nylon material, an insulating core of approximately 1/2-inch-thick polymer-based closed cell foam, a top secured by a zippered interlocking flap, an inner liner of vinyl, a handle or shoulder strap of nylon webbing and plastic fixtures providing a means of carrying the merchandise, and exterior pockets secured by hook-and-loop or zippered closures. Customs classified the merchandise under the luggage provision, which included “Travel goods, such as trunks…satchels, suitcases, overnight bags, traveling bags, knapsacks…and like articles designed to contain…personal effects during travel…and brief cases, golf bags, and like containers and cases designed to be carried with the person…Luggage and handbags, whether or not fitted with bottle, dining, drinking… or similar sets…and flat goods…of laminated plastics…” at a 20 percent rate of duty. Sports Graphics contended that the imported soft-sided coolers were properly classifiable as “Articles chiefly used for preparing, serving, or storing food or beverages” and were dutiable at a rate of 4 or 3.4 percent ad valorem. What is the proper classification? Does the use of this product have a bearing on its classification? Is the chief purpose to serve as “travel goods” or to “serve or store food or beverages”? Sports Graphics, Inc. v. United States, 24 F.3d 1390 (Fed. Cir. 1994).

6. You intend to import raw, frozen calamari (squid) from China, Vietnam, and Peru into the United States, where it will be defrosted and tenderized. The tenderization process entails placing the imported squid into a solution consisting of ice water mixed with salt, citric acid, sodium citrate, active oxygen, and potassium carbonate. The squid is kept at a temperature of 32 to 36 degrees Fahrenheit as it sits in the solution within a large tank for a period of 15 to 18 hours. The process does not change the size or shape of the calamari, but makes it whiter and plumper. Then it is washed with clean water before being refrozen and repacked for sale. Can your calamari be labeled “Product of U.S.A.”? Why or why not? Can you locate any cases like this in the Customs Rulings Online Search System?

7. You intend to import vodka that is produced in Denmark. The strength of the vodka when imported will be at least 80 percent by volume. In the United States, the vodka will be diluted with water, sugar, and flavor to produce flavored vodka with 35 percent alcohol by volume. What is the correct country of origin for labeling purposes? Why?

8. You intend to obtain a saw blade produced in England, ship it to China to be assembled with a handle that is manufactured in China. The finished saw is then packaged in China for export. What is the country of origin of the saw? Why?

Managerial Implications

Your firm is one of the last remaining manufacturers of bicycles in the United States. Z-Mart is a U.S. retail chain with nearly 1,000 stores in fifteen countries. Z-Mart has asked you to prepare a proposal for a large number of bicycles to be sold at discount prices under the Z-Mart brand name. They must have a U.S. retail price of no more than $100. Z-Mart would also like to sell these bikes through its stores in France and Italy in order to compete with the European bikes made in that market. You begin to analyze your costs of materials and production. The first step of production is the sourcing of a tubular frame, a major component. You can purchase the bare frames in the United States, Canada, or Taiwan. You must clean and paint the frames before assembly. The high-performance wheels, another major component, are made from an aluminum alloy. The aluminum is made in Japan and shipped in the form of strips and rods to the Philippines, where it is cut into lengths, molded into wheel parts, and assembled. They will arrive at your plant covered in a film of oil to protect them during shipping. The tires are available from companies in Japan or Brazil. Most of the component parts, such as brakes, gears, and chains, are available directly from firms in the United States and Canada.

At a meeting of management, you are asked to prepare a plan for the production of the bicycles that will price them for Z-Mart’s discount stores. In doing so, you must give consideration to the following questions. (You may make certain assumptions as to the relative costs of materials and labor if necessary.)

1. Explain how U.S. trade and tariff laws would affect your plans for bicycle production. What influence would U.S. tariff preference laws have on the sourcing of component parts? Explain how the rules of origin might affect the importation of the tubular frame. Would NAFTA have any impact on how you structure your operations?

2. What factors would be taken into consideration in determining whether to assemble the finished bicycles in the United States, Taiwan, or the Philippines? You have heard that U.S. automakers are assembling cars in Mexico using workers that are paid about $20 a day. What factors would influence your decision to assemble in Mexico? What processes could you do or not do in Mexico in order to obtain the most favorable tariff treatment? What are the advantages and disadvantages of assembling there?

3. Evaluate the potential for using a foreign trade zone. What advantages or disadvantages would your firm experience in this case?

4. Determine the applicability of U.S. marking and labeling requirements with regard to the finished bicycles sold in the United States.

Ethical Considerations

Fair Trade is a worldwide movement based broadly based on the theory that trade between rich and poor should be based on notions of social and economic justice, and which advocates that small farms and farm workers in developing countries receive a fair price in return for their agricultural and handicraft products. Although the fair trade movement dates to the 1940s, it became popular in parts of Europe in the 1960s and more recently has taken hold in the United States. Fair trade is supported by consumers willing to pay a small additional price for goods knowing that the indigenous producers of the goods, living and working under the poorest conditions, received a fair price for their product. Some fair trade farms consist of small cooperatives, with individual families farming only a couple of acres. Typical fair trade products include coffee, tea, bananas, wine, herbs and spices, honey, rice, and cocoa. Standards, minimum prices, inspections, and certifications of producers and traders are the responsibility of private, nonprofit organizations. Fair trade standards also require that certified farms practice sustainable farming techniques, follow rules on the use of pesticides and recycling, refrain from using child labor, and encourage farm children to attend school. These advances are made possible by the higher prices participants receive for their products.

By the early 2000s, labeling standards for fair trade-certified products became standardized, so that consumers could recognize fair trade products in stores. Participants in fair trade include the workers and producers themselves, the brokers and traders who deal in the products, the retailers and vendors in richer countries, and consumers. Some of the most important fair trade organizations are the Fairtrade Labelling Organizations International, the European Fair Trade Association, the International Fair Trade Association, and TransFair USA.

1. Would you be willing to pay a slightly higher price for sugar, coffee, fruits, and basic commodities, knowing that their producers, farmers in Central America or Africa, were paid an internationally established “fair price” for their labors? Do you believe that consumers will make ethical choices in the marketplace, or economic ones?

2. Fair trade is based on the guarantee of a fair price. How is a “fair price” determined? What is the role of independent fair trade organizations in establishing price?

3. Critics suggest that fair trade does not address the root causes of poverty. Some economists argue that low prices for basic commodities, like coffee, result from oversupply. Moreover, fair trade also does not guarantee access to investment or technology. Do you think the fair trade movement can be successful in rooting out poverty?

4. Although fair trade products account for a tiny volume of world trade relative to the total volume, they do focus concern on the plight of poor farmers, farm workers, and producers in agrarian regions. Some of America’s largest and best-known retailers are selling fair trade products, including Sam’s Club, McDonald’s, Dunkin’ Donuts, Starbucks, and many grocery chains. Based on your research and outside reading, what do you think the impact of fair trade programs can be?

(Schaffer 364)

Schaffer, Agusti, Dhooge, Earle. International Business Law and Its Environment, 8th Edition. South-Western, 2011-01-01. <vbk:1133173535#outline(12)>.