Snell & Wilmer
Global Connection
 

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November 14, 2018

Dear Friend of Snell & Wilmer:

Recent months have brought significant developments to international trade law and other areas affecting U.S. businesses’ international activities. This edition of Global Connection highlights major changes that the new NAFTA (the U.S.-Mexico-Canada Agreement, or USMCA) will bring for North American businesses—as well as one aspect remaining unchanged, the TN visa category. Recent developments have affected land, as well. These include the expansion of the Committee on Foreign Investment in the United States (CFIUS) to impose restrictions on certain real estate transactions for the first time. And, as the United States continues to impose new tariffs, this edition provides guidance for Arizona companies exploring foreign trade zones as a manufacturing option to avoid these new costs.

We hope that this Global Connection proves useful as businesses and individuals work through these and other recent developments highlighted in this edition. If you have any particular suggestions for future editions, or would like to be included in future international events hosted by the firm, please feel free to contact us.

Best regards,

Derek Flint and Lindsay Short
Co-Editors

U.S. Supreme Court Rules Foreign Companies Cannot be Sued Under Alien Tort Statute

by Brett W. Johnson

Earlier this year, a divided U.S. Supreme Court ruled in Jesner et al. v. Arab Bank, 138 S. Ct. 1386 (2018), that foreign corporations cannot be sued for human rights violations under the Alien Tort Statute (ATS), even if the corporation has a U.S. branch.[1]

The ATS was enacted in 1789, but rarely used for more than 200 years. The statute allows foreign individuals to pursue human rights cases in U.S. federal courts for actions occurring overseas that violate “the law of nations or a treaty of the United States.” While originally designed to provide remedies for breaches of customary international law involving diplomats and merchants, human rights organizations began filing suits under the ATS in the 1980s seeking relief for overseas abuses.

The Jesner case involved 6,000 foreign citizens who were victims of terrorist attacks in Israel, the West Bank, and the Gaza Strip. These plaintiffs alleged that Arab Bank, a Jordanian multinational corporation with a branch in New York, had facilitated transactions for foreign terrorist groups, enabling these terrorist attacks. Arab Bank had previously faced U.S. penalties for these actions in 2005, when the U.S. Treasury Department fined the bank $24 million for failing to implement proper anti-money laundering and terrorist financing controls.

Justice Anthony M. Kennedy wrote the majority opinion, explaining that expanding liability to corporations under the ATS is an issue for Congress rather than the judiciary, and expressing skepticism that U.S. courts should be developing norms for foreign corporations. Additionally, the Court explained that this litigation had caused considerable diplomatic tension with Jordan, and that other foreign countries similarly objected to other ATS cases. “The ATS was intended to promote harmony in international relations by ensuring foreign plaintiffs a remedy for international-law violations when the absence of such a remedy might provoke foreign nations to hold the United States accountable,” wrote Justice Kennedy. “But here, and in similar cases, the opposite is occurring. Petitioners are foreign nationals seeking millions of dollars in damages from a major Jordanian financial institution for injuries suffered in attacks by foreign terrorists in the Middle East.”

The Court’s ruling resolved a circuit split as to whether the ATS could be used to sue corporations, clearing up a question from the Supreme Court’s 2013 decision, Kiobel v. Royal Dutch Petroleum.[2] In Kiobel, the Court adopted a presumption that the ATS does not reach human rights violations committed outside the United States, but declined to address whether corporate defendants were inherently immune from suits under the statute. After the ruling in Jesner, foreign corporations with U.S. ties will be protected from suits under the ATS, with potentially significant effects on ongoing human rights litigation in the United States.

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Note:
[1] The full Supreme Court opinion for Jesner can be found at https://www.supremecourt.gov/opinions/17pdf/16-499_1a7d.pdf. [back]
[2] The Supreme Court opinion in Kiobel v. Royal Dutch Petroleum, Co., 569 U.S. 108 (2013), can be found at https://www.supremecourt.gov/opinions/17pdf/16-499_1a7d.pdf. [back]

Four Key Considerations When Pursuing Foreign Trade Zone Status

by Brett W. Johnson and Derek Flint

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.

CFIUS Expansion Brings Federal Review to Real Estate

by David A. Sprentall

On August 13, 2018, the President signed the John S. McCain National Defense Authorization Act for Fiscal Year 2019, which includes the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). This new law amends and expands the scope and responsibilities of the Committee on Foreign Investment in the United States (CFIUS) to include certain real estate and other transactions.

By way of background, CFIUS is a government body originally authorized to review any merger, acquisition or take-over that could result in control of a U.S. business by a foreign individual or entity. The review is intended to determine the effect of a proposed transaction on the national security of the United States. CFIUS members include the Departments of the Treasury, State, Defense, Justice, Commerce, Energy, and Homeland Security; the Office of the United States Trade Representative and the White House Office of Science and Technology Policy. There are other ex-officio and non-voting members on the Committee.

Generally, parties submit notices of transactions to CFIUS for review and determination. To date, submitting proposed transactions to CFIUS has been a voluntary process. CFIUS also has the authority to review pending or completed transactions absent a voluntary notice if it determines that the transaction could raise national security concerns. If the CFIUS review concludes that a transaction poses national security concerns, the committee may seek to have the parties agree on mitigation procedures to resolve the concerns. Ultimately, if concerns cannot be resolved, CFIUS can refer the transaction to the President, who in turn can suspend or prohibit the transaction, including by requiring divestment.

Among other things, FIRRMA expands the scope of transactions that may be subject to CFIUS review to include certain investments in U.S. real estate. Specifically, the amendments expand the scope of “covered transactions” to include: “the purchase or lease by, or concession to, a foreign person of private or public real estate in the United States” that:

  • Is located within, or will function as a part of an air or maritime port;
  • Is in close proximity to a United States military installation or another facility or property of the United States government that is sensitive for reasons relating to national security;
  • Could reasonably provide the foreign person the ability to collect intelligence on activities being conducted at one of those installations, facilities, or properties; or
  • Could otherwise expose national security activities at such an installation, facility, or property to the risk of foreign surveillance.

The statute contains exceptions for certain real estate transactions, including (a) a single “housing unit” and (b) real estate in “urbanized areas” (although this exception could be limited by CFIUS regulations based on input from the Department of Defense). Additionally, subject to regulation, the term “close proximity” is limited to a distance or distances within which the purchase, lease, or concession of real estate could pose a national security risk in connection with a U.S. military installation or another facility or property of the U.S. government.

In addition to the specific expansion to real estate, CFIUS review will include “other investments” by a foreign person in any U.S. business that covers certain aspects of critical infrastructure, critical technologies, or personal data of citizens that could be exploited in a way that threatens national security. The determination of whether a particular investment (including investments by foreign persons in a fund) falls within the scope of the statute will also depend on the nature of the foreign investor’s access to information, voting rights, and decision-making rights.

The new law also expands the CFIUS mandate to include certain joint venture agreements for the first time. It also makes CFIUS review mandatory in certain circumstances, including transactions in which a foreign investor comprised of at least 25 percent government ownership acquires 25 percent or more of the voting interests of a U.S. business.

Additionally, the statute directs CFIUS to adopt regulations with respect to acquisitions and other transactions arising through a bankruptcy proceeding or a default on debt. Presumably, transactions through which a foreign person could acquire an interest in a covered transaction through bankruptcy or enforcement of a security interest could also be within the scope of required review.

FIRRMA also mandated the development of certain regulations and will outline the procedures by which reviews may be requested or initiated, the time limits involved, the scope and enforcement of mitigation agreements, and the penalties for violations.

The expansion of the CFIUS scope to include real estate and certain other investments is not immediately effective. The scope changes will take effect on the earlier of 18 months after the date of enactment or 30 days after the chairperson of the Committee determines that the regulations, organizational structure, personnel, and other resources necessary to administer the expanded scope are in place.

Although the exceptions described above suggest that the application to real estate transactions will be relatively limited, certain key issues will be prescribed by regulations. For example, as stated, even though urbanized areas are excluded, the statute does allow for possible regulatory expansion. Accordingly, it will be important for the real estate industry to consider reviewing and commenting on proposed regulations. In addition, depending on the ultimate scope of the regulations, parties to transactions may want to consider including appropriate representations and warranties and pre-closing conditions in documents, as well as conducting additional due diligence.

TN Visas Remain Under NAFTA Replacement

by Benjamin A. Nucci

Despite rumors that the TN visa category would be eliminated when the North America Free Trade Agreement (NAFTA) was replaced, the new US-Mexico-Canada Agreement (USMCA) appears to preserve the status quo. Consensus over the replacement trade agreement was announced on the evening of September 30, 2018. Notably, the text of USMCA’s Chapter 16 – granting temporary entry for certain Canadian and Mexican business professionals and the right to engage in business activities at the professional level – remains essentially unchanged from the original NAFTA text.

While all three countries are required to ratify the Agreement, U.S. employers seeking to continue to hire professional Canadian and Mexican employees in an expedited and cost-effective manner may view the consensus as a big win. Moreover, it could allow employers with current TN professionals, and the employees themselves, to breath a collective sigh of relief that the visa category may still be available under the finalized USMCA.

NAFTA and the TN Visa

Generally, a citizen of a foreign country who wishes to enter and work in the United States is required to first obtain a visa. In 1992, the United States, Canada, and Mexico entered into NAFTA, which provides, among other things, for expedited temporary admission under the nonimmigrant NAFTA Professional (TN) category of business persons in selected professions from each country, and the ability to engage in employment within those professions. The professions are listed in Appendix 1603.D, see here, which include accountants, engineers, management consultants, social workers, medical professionals, scientists and teachers. See 8 CFR § 214.6. Applicants may be admitted to the United States in TN status for a period of time required by the employer, up to a maximum initial period of three years.

Advantages to the TN Visa

Unlike other visa categories, the TN category provides employees and employers alike with a lot of flexibility provided the purpose of the stay is temporary. The principal alternative to the TN category for employers looking to hire Canadian and Mexican professionals on a temporary basis is the H-1B nonimmigrant category. The big advantages of the TN visa over the H-1B visa include the following:

  • The six-year limit on stay for H-1B nonimmigrants does not apply to the TN category. Instead, TN professionals may receive extensions of stay in increments of up to three years with no outside limits on the total period of stay.
  • Qualified Canadian and Mexican professionals who already completed six years in the H-1B or L nonimmigrant category may immediately apply for the TN category and do not have to fulfill the one-year abroad requirement imposed on H-1B nonimmigrants.
  • There is no annual ceiling on the admission of Canadian and Mexican TN professionals, while the H-1B category has an annual cap. The H-1B annual cap is generally quickly reached, precluding approval of new H-1B petitions for the remainder of the year. For example, on April 6, 2018, USICS announced that it had hit the cap for H-1B petitions for fiscal year 2019 – four days after the first day it accepted filings.

Perhaps one of the most lauded qualities of the TN visa is the procedural advantages when seeking to obtain the visa. Unlike the H-1B visa, employers do not have to submit a petition with U.S. Citizenship and Immigration Services (USCIS) and be subject to processing delays for TV Canadians they want to hire. Instead, Canadian citizens may present their application to a NAFTA officer at a land crossing on the border, or at one of the NAFTA preclearance stations located in various Canadian airports prior to getting on the flight and departing for the United States.

While Mexican TN applicants cannot simply show up at a border crossing to get their TN visa, they do not have to submit their petitions to USCIS. Instead, Mexican nationals seeking initial TN status may apply directly to a U.S. consulate. Notably, both Canadian and Mexican TN applicants may submit applications to USCIS and wait for the agency to adjudicate their petitions.

USMCA and TN Visa Future

In May 2017, the Trump Administration announced its intention to renegotiate NAFTA. The Administration targeted the trade of goods aspect of NAFTA but did not directly take aim at the trade in services. Yet many saw the renegotiation, and the President’s Buy American and Hire American Executive Order seeking the rigorous enforcement of immigration laws, see here, as the end of the TN category under any new trade agreement. USMCA keeps much of the same TN category language of NAFTA. See USMCA here; see NAFTA here.

So what happens next?

While consensus was reached, USMCA still needs to be approved. President Trump, Prime Minister Trudeau, and President Peña Nieto have to sign the Agreement – which they purportedly plan to do before President Peña Nieto leaves office at the end of November possibly at the G20 summit in Buenos Aires, Argentina.

The countries would then need to ratify the Agreement. In the United States, it is unlikely Congress will review USMCA before 2019. Nonetheless, both Republicans and Democrats have supported a trilateral agreement. Notably, Senate Minority Leader Chuck Schumer praised President Trump for renegotiating part of the deal but noted that Congress would need to consider implementation measures for some labor provisions and access to the dairy industry. See here. Equally, incoming Mexican President Andres Manuel Lopez Obrador has stated he would not oppose the deal, see here, and Prime Minister Trudeau has already pledged compensation for Canadian dairy farmers impacted by the deal in an effort to support it. See here. So, for now, the TN category remains.

New NAFTA Creates Opportunities for North American Businesses

by Lindsay L. Short and Brett W. Johnson

The United States, Canada, and Mexico have reached an agreement to update the North American Free Trade Agreement (NAFTA) after more than a year of negotiations. Rebranded as the U.S.-Mexico-Canada Agreement, or USMCA, the new agreement will implement significant updates to the 1994 trilateral trade pact.

The USMCA follows an August 2018 deal between the United States and Mexico, which largely updated NAFTA in the areas of the digital economy, agriculture, and labor unions. As Canada refused to make certain concessions, the White House imposed a September 30, 2018 deadline for releasing its agreement with Mexico. The three countries ultimately came to a new agreement late on September 30.

The USMCA includes several key updates to NAFTA:

Changes to Automobile Manufacture Requirements
Arguably the most significant development, the USMCA will more fully incentivize automobile production in North America. In updating NAFTA’s “rules of origin,” the new agreement now requires that 75 percent of an automobile’s components be made in North America to qualify for zero tariffs (up from the current 62.5 percent).

Additionally, to qualify for zero tariffs, the vehicle’s labor is required to be at least partially completed in a factory in which the average production wage is at least $16 per hour. The threshold will begin at 30 percent in 2020, and rise to 40 percent by 2023. This requirement is considered particularly significant for Mexico, where the typical wage is significantly lower—potentially spurring manufacturing in the United States and Canada. President Trump described the agreement as the “new dawn for the American auto industry.”[1] Ford Motor Company, for its part, stated that it was “very encouraged” by the agreement, which it said “will support an integrated, globally competitive automotive business in North America.”[2]

Loosening of Canada’s Dairy Market
The USMCA also addresses one of the sticking points in NAFTA negotiations: dairy. As background, the Canadian government restricts both the amount of dairy that can be produced in the country, as well as the amount of foreign dairy permitted to enter. President Trump frequently expressed frustration over Canada’s seemingly high tariffs on U.S. dairy products in the last year.

Under the USMCA, the United States will now be able to increase its dairy exports to Canada. Specifically, Canada will eliminate its pricing scheme for “Class 7” dairy products, including milk protein concentrate, skim milk powder, and infant formula. The U.S. export market should open significantly for these products.

Independent Dispute Resolution Remains
Known as Chapter 19, the system that permits the three countries to bring disputes to an independent panel of representatives will remain intact. Canada, in particular, insisted on retaining this provision.

Specifically, Chapter 19 gives each country the right to challenge another’s anti-dumping and countervailing duty decisions. Anti-dumping cases arise when one country claims that another is selling exports below fair value. Countervailing duty cases arise when a government imposes extra tariffs on imports of subsidized goods.

The highest-profile Chapter 19 cases have involved Canada and the softwood lumber industry. Other notable cases have involved the fertilizer, steel pipe, and washing machines industries. With the USMCA, such disputes will continue before an independent panel, rather than one country’s domestic courts.

Increased Environmental and Labor Regulations
The USMCA also updates environmental and labor regulations, particularly focusing on Mexico. It states that Mexican trucks crossing the U.S. border are required to meet higher safety regulations, and that Mexican workers are required to have greater ability to form unions.

New IP Protections
One of the major aims of NAFTA negotiations was modernization. To this end, the USMCA contains a new chapter covering digital trade, which bars duties on e-books and other goods distributed electronically. It also updates protections for patents and trademarks, specifically for biotech, financial services, and domain names.

Tariffs Remain
One issue remains unaffected by the USMCA: steel and aluminum tariffs. The United States’ current 25 percent steel and aluminum tariffs remain in place on Canada and Mexico, pending future negotiations. U.S. Commerce Secretary Wilbur Ross has described those tariffs as “separate issues” from USMCA negotiations.[3]

The key USMCA provisions will not be implemented until 2020, allowing for each country’s legislature to review and approve the agreement. In the United States, Congress is expected to vote in early 2019. Government agencies will also ultimately be promulgating USMCA implementing regulations. In the meantime, companies can consider providing input during the regulatory open comment period, likely beginning in early 2019, to ensure that the needs of their industry and specific business operations are addressed. Companies can also evaluate their existing North American supply chain controls and potential market opportunities that may arise from the USMCA’s implementation.

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Note:
[1] Doug Palmer and Rebecca Morin, “Trump begins push to win approval of new Canada, Mexico trade deal,” Politico, Oct. 1, 2018, available at https://www.politico.com/story/2018/10/01/trump-trade-deal-mexico-canada-nafta-854310. [back]
[2] Christine Romans, “Ford Motor Company: We’re ‘very encouraged’ by this new agreement,” Oct. 1, 2018, available at https://www.cnn.com/politics/live-news/trump-us-mexico-canada-remarks-oct-18/h_2d8e355854248e34f609817e5cde9168. [back]
[3] Christine Romans, “Ford Motor Company: We’re ‘very encouraged’ by this new agreement,” Oct. 1, 2018, available at https://www.cnn.com/politics/live-news/trump-us-mexico-canada-remarks-oct-18/h_2d8e355854248e34f609817e5cde9168. [back]

Understanding the 2018 U.S. Tariffs on Chinese Goods: Developing a Game Plan

by Brett W. Johnson and Derek Flint

The United States Trade Representative (USTR) recently announced a new set of tariffs on imports of Chinese goods.[1] 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.[2] 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.”[3] 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.”[4] 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.”[5] 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.[6] 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.”[7] 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.”[8] 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.[9]

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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Note:
[1] Press Release, Office of the U.S. Trade Representative, USTR Finalizes Tariffs on $200 Billion of Chinese Imports in Response to China’s Unfair Trade Practices (Sept. 18, 2018), https://ustr.gov/about-us/policy-offices/press-office/press-releases/2018/september/ustr-finalizes-tariffs-200. [back]
[2] Doug Palmer, Trump to Slap Tariffs on $200B More Chinese Goods, POLITICO (Sept. 17, 2018), https://www.politico.com/story/2018/09/17/trump-china-trade-war-tariffs-826313. [back]
[3] Section 301, International Trade Administration, https://www.trade.gov/mas/ian/tradedisputes-enforcement/tg_ian_002100.asp (last visited Oct. 12, 2018); see also Caitlain Devereaux Lewis, Presidential Authority over Trade: Imposing Tariffs and Duties, Cong. Research Serv. (Dec. 9, 2016), https://fas.org/sgp/crs/misc/R44707.pdf. [back]
[4] Press Release, Office of the U.S. Trade Representative, USTR Issues Tariffs on Chinese Products in Response to Unfair Trade Practices (June 15, 2018), https://ustr.gov/about-us/policy-offices/press-office/press-releases/2018/june/ustr-issues-tariffs-chinese-products. [back]
[5] Id. [back]
[6] Press Release, Office of the U.S. Trade Representative, USTR Finalizes Tariffs on $200 Billion of Chinese Imports in Response to China’s Unfair Trade Practices (Sept. 18, 2017), https://ustr.gov/about-us/policy-offices/press-office/press-releases/2018/september/ustr-finalizes-tariffs-200. [back]
[7] Vivian Salama, Trump Says He’s Preparing Tariffs on Further $267 Billion in Chinese Imports, Wall St. J. (Sept. 9, 2018), https://www.wsj.com/articles/trump-says-hes-preparing-tariffs-on-further-267-billion-in-chinese-imports-1536340041. [back]
[8] Id. [back]
[9] Lingling Wei & Bob Davis, Trump and Xi Plan to Meet Amid Trade Tension, Wall St. J. (Oct. 11, 2018), https://www.wsj.com/articles/trump-and-xi-plan-to-meet-amid-trade-tension-1539266715. [back]



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