As the United States begins imposing new import tariffs, some Arizona manufacturers are exploring foreign trade zones as a manufacturing option to avoid these costs. But what exactly are foreign trade zones, and how can U.S. companies use them to reduce customs duties? This article addresses options for Arizona manufacturers to develop foreign trade zones within the state, but much of this same guidance applies to companies throughout the United States.

A “foreign trade zone” (FTZ) is a physical zone in the United States that is considered to be outside the country for the purpose of assessing duties and tariffs against businesses within the zone. Thus, manufacturers that import raw materials from outside the country stand to benefit from duty eliminations, duty deferrals, duty reductions, and other logistical benefits that come with operating within an FTZ. Arizona also confers state property tax benefits upon FTZ users.

The process of granting FTZ status is overseen by the FTZ Board in Washington, D.C. The Board grants authority to establish FTZs to local authorities that deal directly with applicants. In Arizona, several cities and economic development authorities are “grantees,” with the power to sponsor local applications for FTZ status. Accordingly, applicants apply for FTZ status to the FTZ Board through these local authorities.

However, the process of obtaining FTZ status can be confusing and filled with red tape for the unprepared developer. While every corporation’s path to FTZ status will present unique challenges, the following are some common issues to keep in mind when pursuing FTZ status.

Issue #1: Make Sure FTZ Status Is the Right Choice for Your Company

Manufacturers often begin exploring FTZ status after learning of the duty reductions. A company can bring parts into an FTZ, build the final product in the zone, and then import the final product into the United States once manufacturing is completed. This allows the company to pay duties either on the final product or on each component. At the same time, the company can use American workers in the FTZ to manufacture the product, rather than sending work overseas.

The FTZ benefit of deferring duty payments until a company imports a good into the United States also applies to the recent U.S. tariffs on steel and aluminum. However, a company cannot avoid the steel and aluminum tariffs by using an FTZ.

Additionally, there can be significant costs associated with an FTZ status. These costs include compliance with U.S. Customs and Border Protection (CBP) regulations and maintenance of the records FTZ manufacturers must retain. There can also be security, software, administrative, legal, and customs costs, depending on the type of FTZ user. Potential FTZ applicants may want to consider preparing a detailed cost-benefit analysis of obtaining FTZ status before deciding to apply.

Issue #2: Understand the Tax Implications

Businesses operating in an FTZ can receive both tariff and state property tax benefits, but the benefits come from different places. Tariff benefits come from federal law and are regulated by the federal government. These benefits include, among others, increased cash flows from duty deferrals, duty elimination for re-exported goods, and inverse tariffs on final goods manufactured in an FTZ.

State property tax benefits, on the other hand, are a product of state law and operate independently of federal tariff benefits. For example, Arizona incentivizes FTZs by reducing the property tax applicable to businesses inside the zones by up to 72.9 percent. But be careful; an FTZ is required to be “activated” by CBP before a user can realize these tax benefits.

Additionally, various local tax bodies are required to consent to the applicant’s use of an FTZ, including the city, school district, water district, and fire district. This process can be time-consuming, particularly if there are multiple local tax authorities responsible for the same site.

Applicants must also understand the impact of FTZ status on current property taxes. While Arizona law provides a property tax incentive to FTZ users, the city of Phoenix will not provide any support to a business attempting to obtain these benefits for existing real or personal property. It is far easier for applicants to receive these state tax benefits for soon-to-be constructed real property.

Issue #3: Determine the Appropriate Type of Site to Pursue

The two main types of FTZs are general purpose zones and subzones. General purpose zones are usually facilities that the general public can use. Subzones are normally single-purpose sites that, for one reason or another, cannot be located in a general purpose zone. General purpose zones sponsor subzones.

There are also two types of FTZs that comprise the Alternative Site Framework (ASF): (1) magnet sites, and (2) usage-driven sites. A magnet site is designed to cover multiple users, who will all independently operate on one FTZ site. A usage-driven site covers only one user, regardless of whether that user operates on a site with other businesses.

Current FTZ trends favor usage-driven sites. The FTZ Board and many local Arizona grantees have benefitted from the streamlined ASF application procedure. The ASF was designed to make it easier and faster for applicants to achieve FTZ status when applying for an FTZ within a grantee’s service area – companies may be approved within just 30 days. However, once a local grantee implements the ASF, it is generally expected to limit its magnet sites to six. Longstanding local grantees, like the City of Phoenix, have often already granted most of these allotted magnet sites. Usage-driven sites, however, are unlimited.

Magnet site applicants also need specific commitments from companies to operate in the FTZ to ensure the FTZ compliance requirements are met. For example, the sunset test automatically removes FTZ sites not used within five years after activation. Therefore, unless a magnet site applicant already has a specific user on board, there is a risk that its FTZ status will lapse before the applicant can bring in any users.

Additionally, a magnet site applicant is required to have an “operator” ready to oversee the recordkeeping and daily operations of the site. This may be the applicant itself or a third party, but it can be difficult to find an operator willing to oversee an entire magnet site’s operations. While a usage-driven site also needs an operator, usually the individual user becomes its own operator.

Issue #4: Prepare the Paperwork Correctly

FTZ applicants should know that their FTZ status is required to both be “approved” and “activated” before they can receive preferential state tax treatment. To activate an approved FTZ site, a separate application is made to CBP. An approved magnet site can remain inactive for up to five years, and a usage-driven site for up to three years. After that time, the approval will lapse.

Applicants also may want to consider a strong tariff rationale, providing an economic justification for granting the applicant’s FTZ status. A good tariff rationale demonstrates how an FTZ status can help the applicant better compete in the global marketplace or increase its use of American labor.

Most importantly, an applicant is required to be prepared to invest the necessary time and resources to complete all the paperwork. An FTZ applicant is required to complete numerous detailed applications and can take more than 15 months to complete.

Obtaining an FTZ status can bring significant benefits for businesses that regularly import products into the United States, reducing or delaying their duties and property taxes. However, the process of applying for FTZ status can be complicated and time-consuming, and the compliance costs associated with maintaining an FTZ are substantial. Any business interested in using an FTZ must fully understand the application process and the effect of FTZ status on operations when exploring this opportunity.