Tariff uncertainty remains as the U.S.-China trade negotiations continue. In late 2018, U.S. Trade Representative (USTR) Robert Lighthizer set a "hard deadline" of March 1, 2019, for a trade deal with China. If no deal is reached, additional tariffs on $200 billion worth of Chinese imports covered by the third tranche of tariffs (known as "List 3") are scheduled to increase from 10 to 25 percent pursuant to Section 301 of the Trade Act of 1974 (Section 301). Furthermore, an additional 25 percent tariff will continue to apply to $50 billion worth of Chinese imports covered by the first two tranches of tariffs (known as "List 1" and "List 2") imposed under Section 301. 

Recently, however, President Trump signaled that he could let the March 1 deadline "slide for a little while" and that "the date is not a magical date." The president has also described the trade talks as "going very well," but cautioned that "they are very complex talks" and "a lot of things can happen." For tariffs to be removed completely, the two sides would likely have to resolve some of the most difficult issues in the current U.S.-China trade relationship, including the enforceability of any Chinese commitments or China's allegedly unfair technology transfer policies. Accordingly, we are currently advising our clients to prepare for long-term tariff uncertainty by considering the tariff mitigation strategies set forth below. 

Companies should take the necessary steps to ensure these tariff mitigation strategies are properly implemented. For example, we encourage clients to memorialize the legal justifications for any change in existing practice and to request binding rulings from U.S. Customs and Border Protection (CBP), when appropriate. Moreover, if you suspect another company is evading tariffs through the improper use of these techniques (e.g., misclassifying products or undervaluing merchandise), consider raising the matter to CBP, which is devoting significant resources to prevent tariff evasion.

• Reevaluate the tariff classification of products sourced from China. The Section 301 tariffs on Chinese-origin products currently affect a little over 60 percent of the eight-digit codes in the Harmonized Tariff Schedule of the United States (HTSUS). While those HTSUS codes account for almost half of imports from China (i.e., $250 billion out of $505 billion), there are currently almost 4,000 eight-digit HTSUS codes that are not affected by the tariffs. As such, companies should take another look at the classification of products sourced from China, considering the applicable legal framework (e.g., the Section and Chapter Notes to the HTSUS, the Explanatory Notes, and U.S. Customs and Border Protection (CBP) rulings). Through additional diligence, some companies are realizing that some of their products were incorrectly classified, a fact that went unnoticed in the past when no duties applied. 
• Reassess the declared country of origin. To determine origin for tariff purposes, CBP applies the "substantial transformation" test. A product assembled from multiple components is deemed to have undergone a substantial transformation if, as a result of the assembly or processing activity, the components are transformed into a new and different article of commerce with a different name, character, or use. In applying this test, CBP examines the totality of circumstances, with a focus on the complexity of the manufacturing or assembly process (e.g., the number of steps, worker hours, tools and technical skill required) and the local value added. Not every product assembled in China is of Chinese-origin for Section 301 tariff purposes, as demonstrated by a few recent rulings where CBP ruled that products assembled in China did not undergo a substantial transformation because their most essential components are foreign-made. 
• Petition USTR for a product-specific tariff exclusion. In its Joint Explanatory Statement accompanying last Friday's appropriations bill, Congress included language that USTR "shall" establish an exclusion process for List 3 products (i.e., the 5,745 tariff codes that cover $200 billion in Chinese imports) if no deal with China is reached. Congress further instructed USTR to follow the same procedures provided for List 1 and List 2 products. USTR is also required to consult with and report to the committees of jurisdiction (the Appropriations, House Ways and Means, and Senate Finance Committees) on the "nature and timing and status of the exclusion process" 30 days after enactment. As such, we believe that a List 3 exclusion process will be very likely in a no-deal scenario. Based on our review of the exclusion requests that USTR has granted for List 1 and List 2 products, successful requests are able to establish that (1) the product is not available from sources outside China; (2) the additional tariffs on the product will cause severe economic harm to U.S. interests (e.g., reduced market share against international competitors, curtailed or reduced U.S. hiring, or cut-backs in U.S.-based research and development); and (3) the product is not strategically important to Chinese industrial policy programs, such as "Made in China 2025." Several successful exclusion requests have included letters of support from Members of the House of Representatives, the U.S. Senate, or local government officials. Such support may have played a role in ensuring that such requests received extra attention, or perhaps even tipped the scales in close cases. Because USTR is likely to review List 3 exclusion requests on a rolling basis, it behooves importers to file their requests as soon as possible after the agency begins accepting submissions.  
• Consider the "First Sale Rule" of customs valuation. Where there are multiple sales of goods prior to their importation into the U.S. (i.e., sales involving an intermediary), the First Sale Rule allows importers, in certain circumstances, to use the price paid in the first or earlier sale as the basis for the customs value of the goods, rather than the price the importer ultimately pays for the goods. The earlier sale price is generally lower because it does not account for the intermediary's markup; thus, using the First Sale Rule can reduce an importer's tariff exposure. Not every multi-tier transaction is eligible for first-sale valuation, however. To qualify, three criteria must be met: (1) there must be a bona fide sale of the merchandise from the manufacturer to an intermediary; (2) the goods must be destined for export to the U.S. at the time of the first sale; and (3) the manufacturer and the intermediary must negotiate at arm's length. Importers that rely on First Sale must maintain a documentation trail to substantiate each of the above requirements.  Accordingly, we generally recommend that importers confer with CBP about whether proposed arrangements with certain key vendors would qualify for First Sale ahead of time, especially now that CBP is scrutinizing this valuation methodology as part of a broader, tariff-related enforcement push.
• Explore duty drawback. Section 313 of the Tariff Act of 1930 authorizes CBP to refund up to 99 percent of the customs duties, fees, and taxes paid to the U.S. government upon importation – including Section 301 tariffs – when the merchandise is subsequently exported or destroyed. There are three main categories of drawback: manufacturing drawback, unused merchandise drawback, and rejected merchandise drawback, each explained in detail here. Our clients have thus far been most interested in a subset of unused merchandise drawback called "substitution unused merchandise drawback," whereby a company may collect drawback if it can demonstrate that merchandise that was exported or destroyed without being used was substituted for imported merchandise classified in the same eight-digit HTSUS code. For example, a medical device company with manufacturing facilities in both China and the U.S. could take advantage of substitution unused merchandise drawback to reclaim Section 301 duties by showing that it (1) imported devices or components from China under one HTSUS code and (2) exported devices or components from the U.S. under the same HTSUS code. Our clients have also sought to take advantage of "rejected merchandise drawback," which can allow companies to reclaim Section 301 duties paid on China-origin merchandise that is imported into the U.S., sold to a customer at retail, subsequently returned by the customer, and then exported or destroyed.
• Tariff engineering. For decades, companies have tweaked the design of imported products to achieve favorable tariff treatment – a practice known as "tariff engineering." The concept of tariff engineering is rooted in the long-standing legal principles that (1) merchandise is classifiable in its condition as imported, and (2) an importer has a right to fashion merchandise to obtain the lowest rate of duty provided it does not resort to fraud or artifice. The general position expressed by CBP in its rulings is that, if the imported product is a "commercial reality" (i.e., the article enters into the stream of commerce in the condition as imported), then tariff engineering is permissible. Thus, tariff engineering can alleviate the tariff burden on products subject to the Section 301 tariffs, but importers must tread carefully.
• Source merchandise from non-China suppliers or perform the finishing step outside of China. Finally, importers may seek to sidestep the trade war entirely by sourcing from countries whose imports are not subject to the Section 301 tariffs. Importers may also consider sourcing components from China but performing final manufacturing activities in a third country with an eye towards effecting a substantial transformation in that third country.

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The strategies discussed in this Trade Flash can help mitigate a U.S. importer's tariff exposure. But companies must exercise caution and be prepared to defend these strategies in the event CBP comes knocking.

For more information, please contact:

Richard A. Mojica, rmojica@milchev.com, 202-626-1571

Collmann Griffin, cgriffin@milchev.com, 202-626-5836

Welles Orr, worr@milchev.com, 202-626-1481

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