Companies are reacting to the global economic crisis by reshaping the way they do business. Corporate reshaping of the supply chain requires detailed attention to customs aspects of the business change. When overlooked, customs issues often result in increased costs or unanticipated barriers to the overall structure.
Ernst & Young, in connection with the Economist Intelligence Unit, surveyed more than 300 C-suite and board-level executives. The report on the survey, titled Opportunities in Adversity (2009), explores how companies are reacting to the global economic crisis, identifying common experiences and leading practices. It is apparent from the report that businesses are seeking to improve performance through entry into new geographic markets, moving operations to lower cost markets, making strategic acquisitions and making other fundamental changes to the business model. Where companies may not have had the appetite for broad business changes in the past, the economic crisis has provided the impetus for change.
For any business involved in the international supply chain, corporate reshaping can have major implications with respect to duty management, customs operations, export controls and other regulatory requirements. In planning, there should be some lead-time to adequately address each.
Corporate reshaping impacts the management of customs duties
Customs duties are not often the main driver of today's corporate reshaping activities. Nevertheless, an increase in global customs duty liability can have a detrimental impact on the tax effectiveness of the supply chain - especially considering that in some jurisdictions, customs duties can be a primary supply chain cost. The process of corporate reshaping involves basic changes to the business model that may result in increased duties.
Altering physical flows or sourcing locations may increase duties
Companies often move some or all of their own production, warehousing, or distribution locations from one country to another. They may also change the sourcing locations of goods from third parties. For instance, a company may change from a local to a centralized distribution model to obtain economies of scale, improve customer service, or obtain tax benefits. A company may also move manufacturing to a lower-cost country to improve margins.
While there are global efforts within the World Trade Organization for duty reduction (and elimination for certain products), each country ultimately defines its own duty rates. Countries may also participate in free-trade agreements or sponsor other special duty-relief programs. Duty rates, free-trade agreement eligibility and many duty-relief programs are based on the nature of the imported product (tariff classification), the country of origin, and the country of importation.
By moving sourcing, production, warehousing or distribution from one country to another, any combination of these three elements that drive duty costs can result in a higher or lower global duty spend. For example:
• Duty rates in developing nations are often higher than in developed nations. Companies that move production from a developed nation to a less-developed nation to take advantage of lower labor costs often find that the duties paid on imported components for the new production site are greater than before.
• Some products that are shipped directly from a less-developed nation to a more developed nation may qualify for reduced duty under a special duty-relief program called the Generalized System of Preferences. Companies that ship these products through a third-country distribution warehouse can lose these benefits by not shipping directly into qualifying countries.
• Free-trade agreements provide for conditional reduced or duty-free importation of qualifying goods between participating countries. To qualify, most agreements require some form of value-added calculation determined by the ratio of the value of originating goods to the total value. Companies that move the source or manufacturing location of their components to locations outside of participating countries for a "lower cost" solution without considering the impact of free-trade agreements run the risk of disqualifying duty-free treatment on their exports, and their customers' exports to participating countries.
Moving profits between related-party entities by increasing the transfer price on related party sales may result in increased duties
Companies often move profits by changing the functions and risk profile of entities within their supply chain, thereby increasing or decreasing the transfer price on sales between related-party entities. For most imports, the customs value is based on the invoice price of the goods being sold and the customs duties are calculated by multiplying the customs value by a product-specific duty rate. Increasing the transfer price on these sales may result in increased duties. For example:
• Companies may move profits away from an importing entity upstream, resulting in an increase of the transfer price on the imported goods and corresponding increase in duties. This is often the case in a principal structure as diagrammed below. When profit is moved from a distributor to a principal, the sales price for finished goods to the distributor is often increased, resulting in increased duties paid by the importing distributor.
Migration or consolidation of intellectual property ownership and related royalty payments may result in reporting obligations, increased duties, and registration efforts
• Companies often migrate or consolidate the ownership of intellectual property globally. Companies may establish IP holders in low-tax jurisdictions or cost-sharing arrangements that require a royalty and/or a buy-in from various parties in the supply chain for the IP's use. Payments made for these rights may represent various underlying types of intellectual property, including technical assistance, designs, formulas, manufacturing rights, trademark rights and trade names. Payments for intellectual property related to imported goods that are not otherwise included in the price the seller charges the buyer for the goods must often be added to the sales price to arrive at the customs value. Migrating or consolidating the IP ownership often results in increased duties and additional reporting obligations. For example:
• Companies that separate the invoicing and payment for IP from the invoicing and payment for the importing goods by changing the IP holder generally must build a process to systematically capture or periodically report the value of the IP for customs purposes. Before the change, the IP is reported as a part of the price for imported goods. After the change, an accounting method to apportion lump sum payments to individual products and a reporting method to report such amounts must be developed and maintained.
• Companies that consolidate a full menu of rights into one contract and one payment run the risk that the entire amount of the payment could be added to the sales price by customs authorities to arrive at the customs value. Not all types of royalty payments must be added. For example, if a portion of the payment is for rights to use sales and marketing IP within the country of importation, that portion (in principle) would not likely be added. Companies often mitigate this adverse treatment by bifurcating the contract and the payment between IP that is required to be added and IP that is not required to be added.
• Customs authorities in many jurisdictions also enforce IP infringement by identification of counterfeit or gray market goods upon importation and seizure. To obtain such enforcement, there is often an IP registration requirement to assist customs in identifying suspect goods. Migration of IP may require additional registration efforts in various countries of importation.
Corporate reshaping impacts customs operations
Another area that should not be overlooked involves the operational issues associated with customs clearance for both imports and exports. Reshaping may affect various customs operational items, requiring the:
• Establishment or change of importer of record
• Establishment or change of the exporter of record
• Creation or replacement of customs bonds
• Modification of commercial documentation
• Provision of additional customs broker/forwarder instructions and establishing new relationships
• Retention, migration or application for import or export licenses
• Migration of participation in trade-related security, compliance and customs simplification programs
• Use of bonded warehouses or similar customs regimes.
There is little global harmonization of customs operational requirements. Local practitioners need to be consulted to evaluate the impact of the change in each jurisdiction.
For example, for tax planning purposes, companies may require that a foreign principal retain title to imported goods held by a distributor up until the point of sale to an unrelated customer. In some countries, a distributor cannot be an importer of record without taking title to the imported goods. Other countries are more flexible, only requiring that the distributor have a financial interest in the transaction. Companies often mitigate this adverse treatment by using a bonded warehouse to store the goods prior to the sale to the unrelated customer.
Corporate reshaping impacts export controls and other regulatory requirements
Reshaping may result in a change of certain regulatory requirements that are administered by customs and other governmental agencies. While this is not an area of customs law as such, there are many "regulatory" licenses and restrictions that may apply to the import and export of goods. Licenses will often have to be presented to the customs authorities before they will allow for an import or export of a particular product. Therefore, when a business migrates to a new jurisdiction or makes changes within an existing jurisdiction, it is essential to identify any regulatory licenses or restrictions that may apply in the future. Without compliance with local regulations it is likely that a business will be unable to operate effectively, as well as face significant penalties for violations - such as in the case of export controls.
Export controls are generally established for "national security" purposes, or to promote other foreign-relations purposes (including embargoes and sanctions). Some of these restrictions are harmonized by various international agreements for the restriction of trade of certain "dual use" items (that could be used for commercial or military purposes alike), nuclear items and certain chemical and biological weapons. Other controls are country specific. Local practitioners need to be consulted to evaluate the impact of the change in each jurisdiction. For example:
• Companies that restructure legal entities may change which economic sanctions rules apply. For example, a change from a Bermuda entity to an EU entity changes compliance obligations with respect to EU economic sanctions rules. Additionally, conversion of a foreign subsidiary of a U.S. company to a foreign branch changes compliance obligations with respect to U.S. economic sanctions rules.
• Companies may be restricted as to their ability to manufacture, own or control certain military goods or related technology. For example, only a U.S. person can obtain licenses to export military goods or technology from the U.S.
• Companies may be restricted or require additional licensing when altering physical flows of goods. For example, an increase in U.S. sourced content in a French manufactured item may render the French item subject to both U.S. and EU export controls. Additionally, drop-shipment structures may require end-destination screening, not just the original sale.
• Other governmental agency requirements are generally product-specific and established to promote "health, safety, and environmental" purposes. These restrictions are generally country- and product-specific. Industries primarily regulated through these types of requirements are pharmaceutical, medical devices, biological, agricultural, chemical, and others. Local practitioners need to be consulted to evaluate the impact of change in each jurisdiction.
For instance, companies that restructure legal entities or locations may run into limitations in practically obtaining required licenses. For example: (1) some licenses require the owner to be a resident; (2) some licenses may be migrated through name change, while others require the new company to reapply, extending the time-frame of business change; and (3) some licenses are location/plant specific and not legal entity specific, restricting the ability to move product.
For any business involved in the international supply chain, reshaping its business model can have major customs implications that, when overlooked, often result in increased costs or unanticipated barriers to the overall structure.
Companies contemplating or making business changes should understand and assess the customs duty, operational and regulatory implications of the changes. Often, the impact can be mitigated through planning if addressed early enough in the process.
The views expressed herein are those of the authors and do not necessarily reflect the views of Ernst & Young LLP.
Source: Ernst & Young
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