[co-author: Derek Flint]
The United States Trade Representative (“USTR”) recently announced a new set of tariffs on imports of Chinese goods. Companies with global supply chains have been scrambling to understand the impact of the tariffs on business operations and, more significantly, on product pricing and alternative sourcing options. In addition to understanding the tariffs’ impact, companies are taking this opportunity to review their entire global supply chains, domestic and foreign product requirements, hidden taxes and fees, and applicable policies and procedures related to global procurement.
Understanding the Various Tariffs
The most recent set of tariffs brings the total amount of Chinese goods subject to tariffs to about $250 billion—approximately half of the $505 billion in goods the U.S. imported from China in 2017. The United States enacted the tariffs under Section 301 of the Trade Act of 1974, which gives the President of the United States the authority to modify specified tariff rates “to enforce trade agreements, resolve trade disputes, and open foreign markets to U.S. goods and services.” It is important to note that the Section 301 tariffs apply in addition to any preexisting tariffs and are separate from the steel and aluminum tariffs implemented earlier this year.
The first question companies are asking is whether the Section 301 tariffs apply to their supply chains. Answering this question requires a company to understand the government’s classification of its products under the Harmonized Tariff Schedule. Usually, the importation of the product is not new, so a customs broker can easily determine what classification has historically been applied to the product. Once a company knows the classification, it needs to determine if the increased tariffs apply to its products. The tariffs on Chinese goods have been promulgated in three lists, each applying to different categories of goods and taking effect on a different date.
List One: $34 Billion on High-Tech Goods
The first list of tariffs took effect on July 6, 2018. It applies to $34 billion worth of goods in 2018 trade values. All goods included in the list are subject to a 25 percent ad valorem duty. List One focuses on goods in high-tech industries, including “aerospace, information and communications technology, robotics, industrial machinery, new materials, and automobiles.” Notably, common household goods like cell phones and televisions are not included in the list. The full list can be found here.
List Two: $16 Billion on Industrial Goods
The second tariff list took effect on August 23, 2018. This list applies a 25 percent ad valorem duty to $16 billion worth of goods that the United States’ Section 301 investigation identified as “benefiting from Chinese industrial policies, including the ‘Made in China 2025’ industrial policy.” Specifically, List Two applies to car parts, railway parts, motorcycles, and fertilizers, among other goods. The full list can be found here.
List Three: $200 Billion on a Wide Range of Goods
The third list took effect on September 24, 2018 and is the most wide-ranging of the three, as it applies to $200 billion worth of goods. Initially, List Three applies a 10 percent ad valorem duty. Beginning on January 1, 2019, however, the rate will increase to 25 percent. The list contains approximately 6000 items, including tobacco products, certain types of food, chemical compounds, and luggage items. Noteworthy products not contained in the list include tablets, televisions, smart watches, certain chemical inputs for manufacturing, certain health and safety products, and child safety furniture. Importantly, unlike List One and List Two tariffs, where the USTR established an exclusion process for U.S. companies (with an application deadline of October 9, 2018), no similar process exists for List Three to date. The full list can be found here.
Proposed List Four
President Donald Trump has stated that the United States has a fourth list of tariffs ready for release on “short notice.” The proposed List Four would apply to $267 billion worth of goods, which would “bring the total amount of goods subject to tariffs to more than the $505 billion the U.S. imported from China in 2017.” The fate of this list, and the three lists already in effect, may be decided when President Trump meets with Chinese President Xi Jinping at the G-20 summit in November.
Preparing for a New Global Supply Chain Model
Once a company has determined that a tariff increase is expected (or already in effect), the immediate question is usually how the company can avoid the tariff. In most cases, this simply is not possible. However, companies may want to determine whether another Harmonized Tariff Schedule classification not subject to the tariffs could apply. If there is a question about whether multiple Harmonized Tariff Schedule classifications could apply, companies may seek a formal determination from U.S. Customs and Border Protection.
Separately, regarding the recent tariffs, companies may seek an exclusion from USTR for the product at issue. The deadline for submitting an exclusion application for Lists One and Two has already passed, and USTR has not announced whether it will allow companies to apply for exclusions from List Three. However, if USTR decides to allow companies to apply for exclusions from List Three, then companies will need to present a compelling argument as to why their products should not be subject to the new tariffs. Importantly, successful exclusions apply to all similar products, not just products from the requesting company. Therefore, exclusions from List One or List Two may already exist for certain products.
Companies unable to avoid the recent tariffs are evaluating alternative supply chains outside of China. But several of the alternatives that provide similar labor pricing and quality are already at capacity. Thus, companies may want to determine whether they are willing to sacrifice quality or absorb higher labor costs. Notably, when companies explore alternative supply chains, several Chinese sources have negotiated with them to either split the cost of increased tariffs or absorb them completely rather than losing the business opportunity. Because many Chinese manufacturers believe that these tariffs are temporary, they may be willing to take the risk of the lower margins.
For future purchases, U.S. businesses are evaluating their standard purchasing agreements to determine whether the shipping terms can be revised to shift the increased tariffs permanently to Chinese manufacturers. This usually involves a revision to a new INCOTERM 2010 term that requires the Chinese manufacturer to bear all shipping costs, including freight, insurance, and export and import duties. U.S. businesses have at times resisted such shifts because they want to control the international compliance requirements, ensuring proper payment of duties and taxes, and leverage economies of scale in relation to freight costs. But due to the increased tariff costs, more companies may shift these risks and benefits to Chinese manufacturers.
U.S. companies may want to consider taking this opportunity to review not only purchasing policies and procedures, but also international trade compliance procedures. When the costs associated with the global supply chain increase, managers look for additional opportunities to save costs. This may include attempting to avoid duties via corruption or inappropriate transshipment. Corruption includes paying a customs official to not apply a tariff. Transshipment improprieties include shipping Chinese-made products to a third country, changing their country of origin labeling, and attempting to import them into the United States at a lower duty rate. This type of action may implicate many other international trade laws. As part of any policy review, employee training may also be important to ensure awareness of the international trade environment.
Regardless of whether the current Chinese tariffs remain in place, it is clear that the strategy of using tariffs as a tool to effectuate changes in balances of trade and protection of intellectual property will continue. The utilization of tariffs in this manner is not new but is becoming more prevalent. As a result, U.S. companies may want to consider using this opportunity to evaluate their entire global supply chains, ensure proper compliance, and maximize risk management.
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