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The following article was first published in the ACC-SC’s Winter 2018 newsletter.
“When elephants fight, it is the grass that suffers.”
--Proverb of the Kenyan tribe of the Kikuyu
The current Presidential Administration is determined to reorient America’s trade relationships with the rest of the world and has decided to use tariffs to accomplish this objective. In so doing, it has started what amounts to a trade war, as many of those countries subjected to tariffs have retaliated in kind.
The purpose of this article is to provide suggestions on how to survive this trade war. In order to do so, however, it is helpful to first understand how we got here.
End of the Long, Low Tariff Era
The last time the United States enacted serious tariff barriers to imports was with the Smoot-Hawley Act of 1930. Smoot-Hawley took the average American tariff on approximately 20,000 imported goods to within a whisker of sixty percent (60%) and, most economists agree, led the world into the Great Depression.
Following World War II, however, the United States gradually lowered its tariffs on imports until the average was around 5%. The U.S. did so for geopolitical reasons which are beyond the scope of this article. The upshot, however, has been that most American businesses have had the luxury of not paying much attention to tariffs for the past 70 odd years.
In January of 2018, however, all of that began to change. The Administration imposed tariffs on solar panels and washing machines of 30-50%. In the Spring and early Summer of this year the Administration imposed tariffs of 10-25% on steel and aluminum imports from most of America’s trading partners and absolute import quotas on those countries not subject to these tariffs.
Finally, beginning in July 2018, the Administration began imposing tariffs on an ever-expanding list of imports from China, to the point where over half of all Chinese imports are now subject to tariffs of between 10-25%. And the shooting’s not necessarily over: the Administration has threatened to extend these tariffs in the very near future to essentially all goods imported by the United States from China.
The Administration has used a variety of legislative vehicles to impose these tariffs: Section 201 of the Tariff Act of 1974 (serious injury to domestic industry standard); Section 232 of the Trade Expansion Act of 1962 (national security) and Section 301 of the Trade Expansion Act of 1962 (violations of trade agreements/burdening US commerce).
The justifications for the Administration’s trade actions, however, are for the elephants to ponder. Down here at the fescue level, our chief concern is: how to advise our clients to defend themselves? Below are 3 survival strategies that attempt to answer this question.
One caveat: the strategies below address only tariffs on imports into the US. If your client exports to jurisdictions that have imposed retaliatory duties on US products, as many have, a discussion of how to deal with those challenges will have to await another day.
Higher Tariffs: Practical Approaches
This article outlines three basic strategies for navigating the Era of High Tariffs:
(1) Modifying supply chains such that tariffs are not triggered;
(2) Leaving supply chains intact but mitigating the impact of tariffs, chiefly by lowering the “dutiable value” of imported products; and
(3) Paying the tariffs due but seeking reimbursement of duties if/when goods are re-exported or pursuing inverted tariff relief.
Modifying the Supply Chain
Modifying your supply chain works best with Section §301 tariffs on Chinese imports. This approach involves converting the country of origin for your imports from China to another country of origin with lower tariffs.
A detailed blueprint for converting the country of origin of one’s imports to someplace other than China is beyond the scope of this article. The essence of this approach, however, is fairly straightforward: ensuring that the final step in the manufacturing process which “substantially transforms” (a freighted term) components and raw materials into the finished, imported product takes place in a country other than China. Country of origin is not determined solely by where the greatest amount of production value was added (although this can be a substantial factor, particularly under certain trade agreements). This means, as a practical matter, that a good deal of the value added in the production of a product could come from China and yet, if the product’s final “substantial transformation” into its end state occurred in, for example, Indonesia, then that product’s country of origin would be considered Indonesia. See Ferrostaal Metals Corp. v. United States, 11 C.I.T. 471, 664 F. Supp. 535 (1987), (the process of galvanizing and annealing steel in New Zealand was sufficient to “substantially transform” full hard cold rolled steel sheet from Japan into a product originating in New Zealand).
It is important to remember, however, that mere “assembly” of a product does not constitute substantial transformation. Accordingly, if a product is essentially manufactured in China but final assembly takes place in Indonesia, such assembly will not constitute substantial transformation and the product’s country of origin will remain Chinese.
In addition, under certain treaties such as NAFTA n/k/a USMCA and KORUS (the Korean free trade agreement), an importer may meet the substantial transformation test simply by showing that the Harmonized Tariff Schedule (HTS) classification of a product has “shifted” from one category to another while in the alleged country of origin.
If your client can’t move at least the final portion of its supply chain out of China, or your client is subject to steel or aluminum tariffs regardless of the source country (so that changing the imported product’s country of origin does not help), then tariff mitigation may be the next best strategy. Tariff mitigation chiefly involves lowering the “dutiable value” of an import, since tariffs are typically levied as a percentage of the product’s value. Significantly, dutiable value may be substantially less than the fair market value of a product.
There are a wide variety of tactics for reducing the dutiable value of an import, a couple of which merit special attention. One these approaches, the “First Sale Doctrine,” holds that an importer may assert as the dutiable value of its product the price at which it was sold from the manufacturer to the first buyer of the product, frequently an export intermediary or middleman of some kind. Thus, the American importer need not declare as the dutiable value the price which the importer is paying to the middleman. Since the middleman’s price frequently involves a substantial mark up, the tariff savings can be quite consequential, frequently as high as 20%.
The First Sale Doctrine can apply even if the middleman is an affiliate of the manufacturer or the American importer as long as each sale is done at arms’ length.
A second approach to lowering dutiable value is to deduct from the cost of the product charges which may properly be excluded, including: the cost of freight, insurance, work done on the product after it arrives in the United States, customs paid elsewhere, terminal handling fees, broker fees, taxes paid and inland freight.
A third approach to lowering dutiable value is to revisit a multinational company’s “transfer pricing” strategy. Prior to passage of the Tax Cuts and Jobs Act of 2017 (the “Trump Tax Cuts”), the American tax code heavily incentivized U.S. companies with a global supply chain or global sales to shelter profits offshore. While an in-depth analysis of the international aspects of the Trump Tax Cuts is beyond the scope of this article, clients should know that the Trump Tax Cuts substantially reduced the aforementioned incentives for sheltering overseas profits offshore.
How does this impact the tariff discussion? Simply put, if there is a greatly reduced income tax incentive to pay high transfer prices to one’s Chinese production subsidiary in order to park profits offshore, and paying high transfer prices to your Chinese production subsidiary increases your tariff bill (since tariffs are levied on the dutiable value of the imported goods), then perhaps it is time to revisit those transfer prices?
Reimbursement of Tariffs
If the client couldn’t avoid paying tariffs can we at least get some of that money back? Perhaps.
To the extent that a company exports products which were previously imported, much or all of the duty previously paid may be reimbursable. This scenario frequently occurs where the imported products are components incorporated into another product which is then exported.
There are two methods for seeking reimbursement of previously paid duties. First, one may apply for a “duty drawback,” by which the government will reimburse 99% of the duties already paid. For example, assume your client imports a window from China on which the client pays a 25% duty. That window is then sold to a mobile home manufacturer and incorporated into a mobile home which is then exported to Brazil. Once the mobile home is shipped to Brazil, the window importer may apply for reimbursement of 99% of the duty previously paid.
A variation of the duty drawback concept involves the use of a Foreign Trade Zone. (“FTZ”). Goods imported into an FTZ are not considered to have been formally “entered” (a term of art) into the customs territory of the United States. Hence, if foreign made goods are brought into an FTZ and subsequently exported, no duty is ever paid.
In addition, if a dutiable component is brought into an FTZ and incorporated into a duty free finished product which is then entered into the U.S. market, then via a process of legal alchemy known as the “inverted tariff,” no tariff is ever paid. 
The above are a few suggestions for keeping your client from getting trampled by warring elephants in today’s trade wars. The essence of these survival tips is as follows: avoid tariffs (if you can) by rethinking your supply chain; if you can’t avoid them, lower them by lowering the dutiable value of your imports; if the previous two strategies don’t work and you must pay the tariffs, try to get at least some of your money back upon export.
Finally, if you can take advantage of the legal alchemy associated with an inverted tariff by using an FTZ, don’t pass up that opportunity.
Jay Rogers is a partner in the Greenville, SC office of Nelson Mullins Riley & Scarborough LLP. Jay provides corporate counsel to U.S. based and international businesses, advising as to economic development incentives, international trade issues (customs, tariffs, etc.), corporate structure, mergers and acquisitions, immigration issues and vendor/customer contracting. Jay can be reached at: 864.373.2216 or at email@example.com.
 By executive order, the “Trump tariffs” imposed under Section 232 and 301 unfortunately may not be avoided via the “inverted tariff,” unlike “normal” tariffs.
Reprinted with permission.
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