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Import Duties: Bend Me, Shape Me, Any Way You Want Me

Small and midsize businesses can use the same customs-duty strategies large multinationals use.
Marie Leone, CFO.com | US
May 8, 2009

Import duties are the unloved stepchild of the tax department at smaller companies. In short, there's a lack of appreciation for the amount of tax planning small and midsize businesses can do with respect to import duties. As a result, companies are missing "significant opportunities" to lower their cost of doing business, says Mark Neville, an international trade and customs attorney with Smith, Gambrell & Russell.

Most of the savings can be gained by viewing import-tax policy as "low-hanging fruit," contends Neville. And that can be captured once finance executives get past the common misconception that customs duties are set in stone.

Unlike income-tax rates, import duties can change dramatically. They may depend, for example, on the way goods or component parts are described, or the way products are packaged and assembled. Consider the classic case of microscopes used for surgery. In the early 1990s, the U.S. International Trade Commission classified surgical microscopes — those with built-in software for hands-free operation — in much the same way it classified laboratory microscopes, which meant the device carried a 7.2% U.S. import duty. Only when manufacturers importing the product successfully argued that the equipment was more akin to a surgical instrument — which is duty-free — than a piece of lab equipment did the government change the microscope's customs status.

Just knowing that an importer has the ability to recategorize items — within reason — could make a big difference to a company's bottom line. Indeed, says Billy Pymm, CFO of Maverik Lacrosse: "How you import products is actually a science. If you know the [importing] categories and how to work with the categories, you'll save your company money."

Part of the science is understanding the subtle differences involved in working with the tariff schedule. For instance, most U.S. clothing manufacturers that import goods know that an oversized cotton T-shirt for women categorized as sleepwear carries an 8.5% duty, while the same shirt marketed as swimwear (as a bathing-suit cover-up) would be saddled with a 14.9% duty. "Ignorance can be bliss, but it can be costly," says Neville, adding that customs duties are more malleable than finance managers might expect.

Another case in point is the different duty rates associated with "retail sets," a selection of products with a common theme. Consider a prepackaged gift, like a spaghetti dinner in a basket. The basket contains pasta, a tin of cheese, a jar of sauce, candles, an apron, and a red-and-white checkered tablecloth, all of it shrink-wrapped and classified as a retail set.

With a little planning, a company may find that assembling the basket outside of the United States and paying duty on a "pasta" retail set may be more cost-effective than importing each item separately and assembling the basket in a warehouse in Tulsa. Or the exercise may indicate the opposite. In either case, running the numbers is worth the time and effort, says Neville.

Strong supply-chain auditing may also help companies uncover savings by stripping out the tariffs levied on markups by middle men, adds Neville. For instance, a hypothetical U.S.-based wholesaler orders $1,000 worth of handbags from a Hong Kong vendor. The vendor, in turn, orders the handbags from a factory in Manila for $850. If the American wholesaler can show through purchase orders that there was an arms-length sale between the Hong Kong and Manila companies, and the handbags are clearly destined for the United States, the customs duties would be assessed against the $850, rather than the $1,000.

Since the duty on handbags is nearly 20%, the company would save almost $30 per purchase order by eliminating the 15% markup by the Manila manufacturer from the tax equation. In such cases, the U.S. government is looking for an audit trail that includes purchase orders from both the Hong Kong and Manila transactions, shipping dates, and drop-shipping instructions that prove the order's final destination is the United States.

The same type of strategy can be applied to goods imported from outside the United States but assembled here. For instance, say an industrial boiler imported from Japan costs $3 million — $2.7 million for the machine plus $300,000 for assembly and installation services once it arrives in the United States. While the physical machine is subject to a tariff, the postimport services are not.

There's one point to remember about such tactics, says Neville: there could be a "tax nexus" issue for the Japanese manufacturer related to U.S. sales tax. Specifically, there could be tax consequences for the Japanese boilermaker depending on whether the machine is assembled by an independent American company or a subsidiary of a Japanese manufacturer, so financial executives may want to discuss the tactic with vendor partners before taking advantage of the tax break.

There's another opportunity for importing companies in "tariff engineering," the practice of designing and marketing a product with the tariff schedules in mind. Neville points to the example of an American manufacturer that designed and marketed a knapsack college students could use as a clothing hamper.

The idea was that students could use the knapsack to comfortably carry dirty laundry and detergent to the nearest washing machines (when they did their laundry at all). The problem, however, was that the manufacturer never checked the import duty on knapsacks, which are categorized as luggage and carry a 17.6% duty, notes Neville. In contrast, other types of sacks and bags hover around the 7% duty mark. Not knowing the tariff schedule "killed them," says Neville.


In general, finance executives tend to ignore import duties because they're buried in either the cost of goods sold or within freight-forward and broker expenses and are rarely an isolated number. Further, import duties are usually relegated to the logistics department and dealt with separately from other corporate-tax issues, says Neville. Indeed, import duties are an indirect federal tax and often aren't included in direct-tax planning, which tends to center on local, state, and federal income taxes.

"There is a marked difference between dealing with income and indirect taxes at a federal level," asserts Neville, who notes that tax-department managers and employees at smaller companies are usually focused on Internal Revenue Service rules and on lowering their company's effective tax rate.

On a practical level, that means companies view income taxes as a fixed amount that can be whittled down via better tax-management strategies. Conversely, says Neville, "customs duties are viewed as something that is just dropped into a file and [treated like] a vendor invoice that has to be paid."

 




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