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Strategies to Cope with Tariffs

by R. Kevin Williams

President Donald Trump has fulfilled promises he made during his 2016 campaign to address inequities in global trade. He has done so by imposing additional tariffs on a host of products from China, which has sparked retaliation.

Before we explore strategies to cope with the added costs of these tariffs, let’s look at how we got here. 

In March 2018, the administration imposed tariffs of 25 percent on steel and 10 percent on aluminum imports. The EU, Argentina, Australia, Brazil, Canada, Mexico and South Korea were initially exempt, but the tariffs were extended to Canada, Mexico and the EU at the end of May. Australia remains exempt, while steel from Brazil and South Korea, and steel and aluminum from Argentina, are subject to quotas instead of tariffs. 

The first round of tariffs against China took effect in July, with 25 percent tolls on $34 billion of Chinese goods. The tariffs affected products such as machines, auto parts and other industrial goods. A second round of tariffs in August imposed 25 percent levies on another $16 billion of Chinese goods, including plastics, more auto parts and additional machines.

A third round in September resulted in the imposition of a 10 percent tariff on an additional $200 billion of Chinese goods. The tariff on these latter products was scheduled to increase to 25 percent in January, but the administration postponed the increase, citing progress in negotiations. 

In mid-May, negotiations with China grew tense, and the administration increased the tariffs to the previously threatened 25 percent and warned of tariffs on another $325 billion in Chinese goods.

China, the EU and other trading partners have retaliated over several months by imposing tariffs on U.S. goods. The EU’s tariffs apply to agricultural goods, motorcycles, and boats, among other products. China cancelled purchases of U.S. soybeans and imposed tariffs on $60 billion of U.S. exports. Canada and Mexico also imposed retaliatory tariffs.

These tariffs resulted in unexpected and substantial increases to the cost of goods imported by many U.S. companies. The common short-term strategies to deal with these additional costs were to absorb them, renegotiate price agreements with customers, or a combination of the two.

Companies may also employ these four longer-term strategies to mitigate the impact of tariffs:

Request exclusions;

Confirm the tariff classification of imported goods;

Tariff engineering; and

Modify supply chains.

Exclusions

Except for the tariffs imposed by China in September, the government established a process for importers to request exclusions. Requests for exclusion from the steel and aluminum tariffs have been the most successful. Of the 51,345 requests submitted by this spring, more than 25,000 have been approved, more than 7,000 have been denied, and the rest are pending. Requests for exclusion from the steel and aluminum tariffs may be submitted any time.

Nearly 14,000 requests for exclusion from the first two rounds of China tariffs were submitted before the filing deadlines. Of these, only 1,442 exclusions have been granted for the first round, while more than 5,000 have been denied. The remainder of the requests for the first round, and all those for the second round, remain pending.

An exclusion process for the third round has not been established. 

These statistics indicate that exclusions from the steel and aluminum tariffs are not a sure thing but worth pursuing, given that the process remains open. 

The China exclusion process was far less rewarding but also worth the effort; the possible benefits far outweighed the potential cost. Unless the process is reopened for the first two rounds, or initiated for the third round, additional exclusion requests will not be accepted.

Classifications

A second mitigating strategy is to confirm the classification of imported goods in the Harmonized Tariff Schedule of the United States (HTSUS). The HTSUS classification of a product establishes the general duty rate and whether the product is subject to the additional tariffs.

The confirmation of a product’s tariff classification is a highly recommended exercise for two reasons. First, a product may appear to be subject to the tariffs, but a review may reveal that a product is not appropriately classified, and its revised classification is exempt. For example, a steel tube product from Canada that has been further manufactured for use in an exhaust gas recirculation system is not classified as a steel tube, but as a heat exchanger part. The former is subject to the steel tariffs, while the latter is not. 

The second reason to confirm the tariff classification is the inverse of the first. That is, a company may be importing a product under a classification that is not subject to the tariffs, but if this classification is incorrect, the importer may be assessed the additional tariffs, as well as penalties, if Customs discovers the error. Customs penalties range from two to four times the underpaid duties if the error results from simple negligence or gross negligence, respectively. If the violation results from fraud, the penalty can be up to the domestic value of the merchandise. 

Engineering

Tariff engineering is also an effective strategy to mitigate the impact of high tariffs. It is an established practice dating back to a Supreme Court decision in 1881. In that case, the Supreme Court affirmed an importer’s right “to manufacture his goods as to avoid the burden of high duties.”

A recent example of tariff engineering involved Ford Motor Company’s imports of its first-generation Transit Connect vehicles. Light trucks, including cargo vans, were then and still are subject to 25 percent tariffs, while the duty on passenger vehicles is 2.5 percent. The high tariff on cargo vans was the result of a chicken war between the United States and Europe. This trade war started in 1962 when imports of poultry from the United States caused prices to collapse in Europe. France, then Germany, increased tariffs on U.S. chickens. The U.S. retaliated by imposing 25 percent tariffs, which is often referred to as the chicken tax, on brandy, light trucks, and other products. The tariff on light trucks drastically affected Germany’s exports of the vehicles, as well as those from Japan and other countries.

The Japanese and German automakers soon began to utilize tariff engineering to avoid the chicken tax. The Japanese shipped truck chassis to the U.S., which were subject to a 4 percent tariff, and added the beds after importation. Mercedes shipped its Sprinter vans to the U.S. in kit form for assembly in South Carolina with a proportion of U.S. sourced components. The missing components were strategically selected to ensure that the kits were not classified as unfinished light trucks. 

Ford’s strategy pushed the concept of tariff engineering even further. The company imported its Transit Connect vans with a second-row seat and second-row sliding doors with windows. After the vans cleared Customs, Ford removed the second-row seats and, in some cases, replaced the windows in the second-row sliding doors with a solid panel.

Customs concluded that Ford’s strategy was not valid tariff engineering but was intended to disguise the true nature of the vehicle at the time of importation. Ford challenged the decision, and in 2017, the Court of International Trade held that the condition of the vans at the time of import controlled their classification, and the motive of the importer in designing the merchandise is not relevant.

The government has appealed this decision. While the appellate court may determine that Ford pushed the boundaries of tariff engineering too far, it will not overturn the long-standing precedents recognizing the legitimacy of tariff engineering.

Supply Chain Changes

The final strategy is to consider modification of existing supply chains. The central question is whether a product’s sourcing can be shifted from a country subject to the tariffs to one where it is not. An obvious example of this would be to shift the source for imported products to domestic sources. 

Another possibility is to shift sourcing from one foreign country to another. For example, aluminum foil imported into the U.S. from China is subject to the aluminum tariffs, as well as antidumping and countervailing duties. Some companies with existing production capacity in other countries have adjusted their supply chain so that the foil is shipped from China to these alternative production facilities, where the product is manufactured and then shipped to the U.S., where it will not be subject to the tariffs. The analysis of such supply chain modifications involves both cost considerations, as well as application of U.S. laws governing the determination of a product’s country of origin. 

Each of these strategies can be used successfully to reduce the impact of the tariffs. Consider each as it relates to company’s supply chain configuration. 

R. Kevin Williams is a member in Clark Hill’s International Trade Law practice group. His practice focuses on governmental regulation of imports and exports. Williams spoke at the 2019 Supply Summit & Showcase.