Trump’s Tariff Wars: Mitigating the Risk for Supply Chains

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Dechert LLPThroughout his presidency, President Trump has used tariffs – and the threat of tariffs – to address an unprecedented variety of economic and national security threats. As if to underscore the point, on December 2, 2019, the Trump Administration announced or threatened new tariffs in response to three different disputes:

  • President Trump announced steel and aluminum tariffs on Brazil and Argentina to counter the alleged manipulation of their currencies;
  • Robert Lighthizer, the U.S. Trade Representative, released the results of a Section 301 investigation into a French digital services tax, calling for punitive duties of up to 100% on $2.4 billion in French agricultural and consumer products; and
  • Secretary of Commerce Wilbur Ross again threatened increased tariffs on consumer goods from China if a trade deal with Beijing is not reached by December 15.

The Administration has used a variety of legal authorities to impose or threaten tariffs, including Section 232 of the Trade Expansion Act of 1962 – which authorizes import duties for national security purposes – and Section 301 of the Trade Act of 1974, which is intended to address discriminatory or unlawful trade practices. The Administration threatened tariffs against Mexico under the International Economic Emergency Powers Act in June 2019, which historically has provided the legal basis for national security measures such as sanctions and export controls.

The Administration has used tariffs to target both adversaries and allies, and to address all manner of disputes, ranging from broad national security and economic interests (such as the China tariffs) to discrete disputes (such as those tariffs imposed in response to a World Trade Organization ruling that European countries unfairly subsidized Airbus, to the detriment of Boeing). Unexpected tariffs disrupt supply chains and can lead to increased costs for manufacturers and consumers. While some had expected tariffs to be temporary, there are no signs of permanent abatement. For companies that had adopted a wait-and-see approach and for those now facing the impact, it is time to consider mitigation strategies.

Strategies to Mitigate Tariff Impact

With the globalization of supply chains, diversified manufacturing, and international customer bases, it is the rule – not the exception – that companies find themselves in the middle of the Trump Administration’s trade disputes. Trade compliance and risk management officers must identify risks – a complicated task that grows more complicated as a company’s global footprint expands. Once those risks are identified, the heavy lifting of crafting and implementing a mitigation plan begins. We address a few key mitigation strategies below.

Product Classification. U.S. tariffs are based on a product’s specific customs classification under the Harmonized Tariff Schedule (“HTS”). Companies should carefully assess the technical specifications of imported products, including a review of published customs classification rulings for similar products and interpretative guidance, to verify the proper HTS code and then assess whether that code is or may become subject to tariffs.

  • Offensive measures. Confirming or re-classifying a product’s HTS code can be a simple method to avoid the significant impact of tariffs. Reviewing classifications is especially important for the China tariffs, because there are different tariffs, ranging from 15% to 25%, for different categories of goods and with different effective dates.
  • Defensive measures. A company’s determination of the correct HTS classification is often done without government visibility, and with the threat tariffs pose to the bottom line, some companies may be incentivized to get creative with HTS classifications. If a competitor is avoiding tariffs that your company is paying, this can be brought to the attention of the authorities.

Country of Origin. Tariffs are based on the country of origin. Companies with distributed manufacturing operations can consider altering their manufacturing processes to change the country of origin.

  • Manufacturing abroad. We have seen companies shift manufacturing from China to locations such as Mexico, Vietnam, Taiwan and South Korea. For example, Chinese parts can be imported into Vietnam, combined with parts from Vietnam or other countries with further manufacturing, and substantially transformed into a new article in Vietnam. The product then can be exported to the United States as a product of Vietnam, with no tariffs. The rules determining country of origin must be scrupulously followed in such situations, and their application can be highly fact specific based on the product involved. A wrongful declaration of origin could result in customs fraud charges.
  • Manufacturing domestically. Companies can import raw goods or components that are not subject to tariffs in order to manufacture in the U.S. a finished commodity that would otherwise be subject to tariffs if imported in its finished form. This is what the Trump Administration hopes will occur as a result of the increased tariffs. Setting up domestic manufacturing is a long-term process, and some companies may be looking for more short-term adjustments while waiting to see what happens with the 2020 elections. Another consideration is that many U.S. manufacturers are now facing increased production costs, to the extent their inputs have become subject to tariffs.

Exclusion Requests. The U.S. government, through the Department of Commerce and the U.S. Trade Representative, has established procedures that enable industry to petition for exclusions on products that are otherwise subject to heightened tariffs. If granted, an exclusion request negates the tariffs. Successful exclusion requests present a compelling narrative, supported by factual data about the company’s operations, and describing how the subject merchandise is not available in the U.S. or a third country that is not subject to the tariffs. Importantly, exclusion requests should demonstrate the severe economic harm to the applicant and U.S. industry if the product remains subject to tariffs. In the case of China tariffs, it is important to make the case that an exclusion for a certain product would not undermine U.S. trade policy goals towards that country. The UTSR’s statistics demonstrate the difficulty in obtaining an exclusion request. To date, only 1,234 exclusion requests have been granted across the USTR’s first three China tariff list programs. On September 30, 2019, the exclusion request period for tariff List 3 closed, with the USTR having received 30,302 requests. Of these, less than 1% (236) were granted, 17% (5,073) were outright denied and the remaining 82% (24,993) are pending substantive USTR review. The List 4 exclusion request period has now opened. Although exclusion requests can be time consuming to prepare and require patience for a ruling, getting an exclusion can be a big win. The exclusion is retroactive to the date when the tariffs went into effect for USTR’s China program, and the date the exclusion request was submitted under the Commerce 232 program, so large amounts of money can be at stake.

Duty Drawback. A duty drawback is the refunding by U.S. Customs and Border Protection of duties and certain related fees that are paid at the time of import. In order to qualify, the imported merchandise subject to the tariff (or a substitute product) must be subsequently exported, for example after manufacturing in the U.S. Duty drawback is more flexible than many realize, in that the export of a similar product can offset the import duties. The duty drawback process is complex and puts a significant onus on U.S. companies to maintain detailed records. However, it is a reliable process, and it has not been subject to sudden changes based on politics. This reliability makes it attractive. Implementing a comprehensive duty drawback compliance program can result in a significant offset of the potential tariff liability, although it can also create a temporary strain on cash flow while refunds are pending.

Foreign Trade Zones and Bonded Facilities. The use of foreign trade zones and bonded facilities can also be tools to reduce tariff exposure. Goods imported into a bonded facility that are substantially transformed in the trade zone before they are entered into the U.S. can escape the tariffs. In a related manner, goods subject to the tariffs may be temporarily imported into a bonded facility. If the goods held in a bonded facility are subsequently exported to a third country, they would not be subject to tariffs. Similarly, companies may use a bonded facility to store goods in an attempt to wait out the tariffs. This strategy was considered when a China trade deal seemed imminent. Commodities in a bonded facility would not be subject to increased tariffs for up to five years, unless and until the product is entered into U.S. commerce for consumption. However, storage costs and delays in access to inventory and manufacturing inputs can make lengthy holding of goods in a bonded warehouse impractical.

Conclusion

The Trump Administration’s enthusiasm for using tariffs as a favorite foreign policy tool continues, as shown by the Dec. 2 announcements. In the present environment, it is critical for companies to proactively monitor and evaluate the risk tariffs may pose to their business. Although mitigating the potential impact of tariffs may have an upfront cost, a well-developed and executed risk mitigation plan can have enormous competitive advantages, and in some cases may even preserve the viability of the business.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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