The U.S.-China Trade War: Country of Origin,
Substantial Transformation, and Risk
Mitigation
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WEDNESDAY, DECEMBER 12, 2018
Presenting a live 90-minute webinar with interactive Q&A
Eric C. Emerson, Partner, Steptoe & Johnson, Washington, D.C.
Richard A. Mojica, Member, Miller & Chevalier, Washington, D.C.
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U.S.-China Trade War:
Country of Origin, Substantial Transformation and Risk Mitigation
Eric Emerson
Partner, Steptoe & Johnson LLP
Richard Mojica
Member, Miller & Chevalier Chartered
December 12, 2018
6
Agenda
• Update on U.S. and retaliatory tariffs
• Tariff mitigation strategies
• Outlook on U.S.-China trade policy
• Q&A
UPDATE ON U.S. AND
RETALIATORY TARIFFS
8
U.S. Tariffs: Legal Authority and Justification
Section 301 of the Trade Act of 1974
LEGAL
AUTHORITYAuthorizes USTR to take action if it determines a country is violating
a trade agreement or has policies that are discriminatory and
burden or restrict U.S. commerce.
JUSTIFICATI
ONConcerns about China’s unfair IP, tech practices
• China’s “Made in China 2025” program
• Foreign investment restrictions to spur technology transfer
• Cyber espionage to obtain IP, trade secrets, other business info
PRODUCTS
COVERED
BY
ADDITIONAL
TARIFFS
List 1 (Apr. 3):
• $34 billion, 818 tariff
lines
• “Industrially significant”
Chinese products
• 25% additional tariff
List 2 (June 15):
• $16 billion, 279 tariff
lines
• Mostly industrial
products, Chemicals
and electronic parts
• 25% additional tariff
List 3 (July 10):
• $200 billion, 5,745 tariff
lines
• Wide range of
products, including
consumer goods
• 10% additional tariff
• Increases to 25% – on
hold
9
Chinese-Origin Products Covered by U.S. Tariffs
Image Source: Wall Street Journal, Petersons Institute (tariff values); Census Bureau (total trade)
• Capital goods– Machines for making integrated circuits
– Other industrial machinery (e.g. forklifts)
– Circuit breakers
– Nuclear reactors
• Intermediate goods– Integrated circuits
– Plastic components
– Metal components
– Chemicals
• Consumer goods– E-Bikes, scooters
– Leather handbags
– Furniture
• Remaining goods– Smart phones
– Toothbrushes
– Certain apparel & footwear
– Children’s toys
PHASE 1(Lists 1 & 2)
PHASE 2(List 3)
Free ofTariffs
U.S. IMPORTS FROM CHINA
10
U.S.-Origin Products Covered by Chinese Tariffs
• Capital Goods– Electrical connectors
– Tractors
– Autos, buses
– Medical equipment
• Intermediate Goods– Coal, fuel oils
– Chemicals
– Plastic products
– Grease, Vaseline
– Auto parts
• Consumer Goods– Fruit & nuts
– Soy products
– Wine
– Pork products
CHINESE IMPORTS FROM U.S.
PHASE 1(Lists 1 & 2)
PHASE 2(List 3)
Free ofTariffs
Image Source: Wall Street Journal, Petersons Institute (tariff values); Census Bureau (total trade)
11
Trade War “Truce” at G20 Summit
• U.S. will delay planned duty
increase to 25% for “List 3”
products
• China will increase purchases
of agricultural, energy,
industrial, and other products
from the United States
• U.S. and China to negotiate on
“structural changes” to China’s
technology transfer practices
12
Reaction by U.S. Companies to Tariffs
• Frontload orders to import
goods before scheduled
increase from 10 percent to
25 percent
• Cut back orders of low-margin
products from China
• Negotiate price concessions
from vendors
• Tariff mitigation strategies
TARIFF MITIGATION STRATEGIES
14
Tariff Mitigation Strategies:
Explore Alternative HTS Codes
• Advocate for an HTS code not covered by tariffs
– More of an art than a science; don’t just “look up the number”
• Consider:
– General Rules of Interpretation (GRIs)
– Section and Chapter Notes to the HTS
• “This Chapter does not cover”
• “Parts of machines are to be classified according to the following rules”
• Multi-function machines are classified according to their principal function
– WCO Explanatory Notes
– CBP rulings (publicly available on CROSS: https://rulings.cbp.gov)
• But be careful ….
– Seek a ruling or memorialize justification for a classification change
15
Tariff Mitigation Strategies:
Explore Alternative HTS Codes – Case Studies
Case Study 1:
Auto Part or Spring?
Case Study 2:
Alarm Clock or Meteorological
Instrument?
• Chinese-origin spring used in auto break caliper
assembly
• 27.5% duty if classified in subheading
8708.30.50 (auto brake parts)
• 2.9% duty if classified in subheading
7320.90.5060 (springs)
• CBP classified as a “spring” applying Note 2(b)
to Section XVII, which excludes “parts of general
use” (including springs) from heading 8708
• Chinese-origin alarm clock with weather
forecasting features
• 25% duty if classified in subheading
9015.80.8080 (meteorological instruments)
• 3.9% if classified in subheading 9105.11.40
(alarm clocks)
• CBP classified as an “alarm clock,” because GRI
3 says look to “essential character” when two or
more headings are prima facie applicable and
clock features predominate
16
Tariff Mitigation Strategies:
Reassess Country of Origin
• Origin of product not always clear-cut – especially for assembly
operations involving components of multiple origins
• For Section 301 tariffs, Country of Origin (COO) is determined by
“substantial transformation” test
• A substantial transformation occurs when an article has been
subjected to a process which results in a change in name,
character or use
• Fact-intensive, totality-of-the-circumstances analysis. Key
considerations are:
– extent of the operations performed
– whether the individual components lose their identity and become an integral part
of the new article
– Nature of the assembly (simple vs. complex)
17
Tariff Mitigation Strategies:
Reassess Country of Origin
• Change in name – components
become “indistinguishable in name
from the finished product” as a result of
manufacturing/ assembly process
• Change in character – manufacturing/
assembly process changes
components’ features, shape, material
composition, etc.
• Change in use – end-use of imported
product is no longer interchangeable
with end-use of product after
manufacturing/ assembly
18
Tariff Mitigation Strategies:
Reassess Country of Origin
Court of International Trade (CIT) in Energizer Battery (2016):
• Flashlight components manufactured in China and assembled in Vermont
• CIT found no substantial transformation, because:
– Components retained name because still distinguishable within final product
– Components retained characterbecause no change in features, shape, or materials
– Components had pre-determined use prior to importation
• Therefore, COO is China
Mere assembly of flashlight components involves no change in
components name, material, shape, features, or use, so no substantial
transformation.
19
Tariff Mitigation Strategies:
Reassess Country of Origin – Case Studies
Case 1:
Mexican Elec. Motors
Case 2:
Chinese Solar Panels
Case 3:
Turkish Bus Doors
Chinese motor sub-
assemblies imported into
Mexico and assembled into
DC electric motors
Polycrystalline solar cells
manufactured in Germany
and inserted into frames in
China to create solar panels
German-origin raw
polyurethane materials
molded into components for
bus doors in Turkey
• CBP holds COO is
China: Chinese
subassemblies had a
pre-determined end-use,
did not undergo change
in use due to assembly
in Mexico
• Additional 25% tariff
applies
• CBP holds COO is
Germany: solar cells
“constitute the very
essence of the solar
panels”
• No additional 25% tariff
CBP holds COO is Turkey,
because molding of raw
polyurethane changed
name, character, and use of
material
20
Tariff Mitigation Strategies:
Reassess Country of Origin – Takeaways
• Substantial transformation is a subjective test
• Assembly in China does not necessarily mean the COO is China,
especially when:
– The “essence” or “guts” are made in another country
– The assembly operations are relatively simple
– The components have a pre-determined use at the time of importation
• Helpful information to determine origin:
– Bill of materials (BOMs) showing cost and country of origin of each component
– Step-by-step narrative of production process
– CBP rulings
21
Tariff Mitigation Strategies:
Tariff Exclusion Requests
• USTR may grant one-year, product-specific
exclusions from tariffs
• Requestor must show:
– Tariffs will cause severe harm to U.S. economic
interests
– Product has not benefited from unfair Chinese
industrial policies
– No non-Chinese supply
– Exclusion will be administrable by CBP
22
Tariff Mitigation Strategies:
Tariff Exclusion Requests – Results Thus Far
Denials (1,487)
Pending Approval by USTR & CBP (9,467)
Approved by USTR; Pending Approval by CBP(612)Approvals (0)
USTR Exclusion Requests
(11,566 as of Nov. 29)Exclusions are difficult – but not
impossible:
• 612 exclusion requests have
been approved by USTR,
pending CBP review for
administrability
• Because exclusions are not
tied to specific
producers/importers,
competitors can import
products under any exclusion
granted so long as product
meets exclusion criteria
23
Tariff Mitigation Strategies:
Tariff Exclusion Requests – Winning and Losing Arguments
USTR factor Losing Argument Winning Argument
Harm to U.S. Interests Vague descriptions of harm
• Increased 25% tariff will result in
additional costs that must be passed
on to distributors and consumers
Concrete/particularized descriptions
of harm
• Increased 25% tariff will create severe
cost environment for company – costs
will rise over $8 m annually
• Company will be forced to reduce its
current employment levels in both
Ohio and Michigan and freeze future
engineering and development
expansion
Non-Chinese Supply Non-Chinese product is higher cost
• There are several other Asian
countries capable of manufacturing
these products, however at a cost
15%+ that of China.
Non-Chinese product is not available
in sufficient quality, quantity, etc.
• Production line must be approved in
advance by end customer for
production machinery, manpower,
etc.; to date, no non-Chinese facilities
approved
Administrability Vague description
• Request for “a liner actuator with a
single rod and body that is extended
and extracted using pneumatic
pressure.”
No approvals yet.
24
Tariff Mitigation Strategies:
Tariff Exclusion Requests – Improving Your Odds
Companies have supported
exclusion requests with strong
public policy efforts.
• Many members have been
willing to go to bat for their
constituents
• Need evidence of harm to U.S.
interests
25
Tariff Mitigation Strategies:
Valuation – “First Sale” Rule
• In multi-tier transactions, customs valuation can be based on “first
sale” of product from manufacturer to intermediary rather than
subsequent sale from intermediary to importer
• Lower first sale price → lower valuation for tariff calculation
purposes
• Three requirements:
– Transaction upon which the value is based must be a bona fide sale
– Goods must be destined for export to the United States
– Transaction must be at arm's length, meaning the parties must behave as if there
were no relationship between them (even if they are in fact related)
• First-sale valuation requires documentation, objective evidence
26
Tariff Mitigation Strategies:
Alternative Sources of Supply and Tariff Engineering
• Alternative Sources of Supply
– Source product from outside China
– Source component that imparts essential character (e.g., a bicycle frame) from
outside China
– Relocate the processing steps that result in substantial transformation outside
China
• Tariff Engineering
– Courts make clear that CBP can only levy duties on products in “condition as
imported”
– Allows importers to legally adjust supply chain to ensure product enters United
States under favorable tariff subheading
– Fine line: cannot rise to level of “fraud or artifice”
27
Tariff Mitigation Strategies:
Tariff Engineering – Case Studies
Case Study 1:
Ford Transit Connect Vans
Case Study 2:
Columbia Rubber-Soled Shoes
• Ford imports vehicles from Spain then
removes rear seats, seat belts, covers
rear windows in port
• CBP: “Cargo van” dutiable at 25%
• U.S. CIT: “Passenger vehicle” in
condition as imported – regardless of
later changes – dutiable at 2.5%
• Columbia imports shoes and boots with
“super-thin sheath of fabric” attached to
rubber sole
• Fabric wears off within days, revealing
rubber beneath.
• Columbia pays 12.5% duty on fabric
soles, not 37.5% on rubber soles
28
Tariff Mitigation Strategies:
Other Options & Considerations
• Drawback
– Allows 99 percent refund of duties and fees paid on goods subsequently
exported
– “Substitution drawback” available if products of same kind and quality are
subsequently exported
– CBP makes clear drawback is available for Section 301 duties
• Contingency measures in supply agreements
– Force majeure clauses may not meet legal requirements for contract termination
on the basis of unanticipated customs duties
– Performance of the contract must be virtually impossible
– New sales contract language – e.g., a “price review” clause permitting parties to
renegotiate prices under certain circumstances
29
Tariff-Driven Customs Audits on the Horizon
• CBP recently hired 60 new Regulatory Audit
staff around the country
• CBP’s Centers of Excellence and Expertise
(“CEEs”) will focus on any changes to import
information – e.g., COO no longer China
• CBP has reportedly issued first wave of CF-28
“Requests for Information” in connection with
additional tariffs
• For all tariff mitigation strategies, prepare well-
documented analysis of basis for change
• Consider engaging counsel or seeking binding
rulings from CBP
OUTLOOK ON
U.S.-CHINA TRADE POLICY
31
Washington Outlook:
Challenges to Long-Term U.S.-China Trade Deal
• “Truce” covers only List 3
– Postpones increase in duty from 10% to 25% until Feb 2019 (probably)
• Lack of clear agreement on terms of the “truce”
• A wide range of issues, with different chances of success
– Increased purchases of U.S. products could be done quickly
– Revising China’s technology transfer practices could be easy, though
enforceability may be difficult
– Fundamental changes to China’s industrial policy are unlikely
• Other irritants
– Arrest of Huawei CFO
– Strengthening of U.S. export controls
– Sanctions on Fujian Jinhua for trade secret theft
32
Washington Outlook:
Complex U.S. Domestic Politics on Trade War
• Trade War has led to unlikely allies
– Senators Schumer (D-NY), Wyden (D-OR) and Brown (D-OH) have supported
hard line against China
• Divisions within the Administration
– U.S. Trade Representative Robert Lighthizer and White House Trade Policy
Advisor Peter Navarro support hard line against China
• Lighthizer has been selected as lead negotiator
• USTR issued supplemental Section 301 report in late Nov 2018
– U.S. Treasury Secretary Steven Mnuchin appears to favor truce
33
Beijing Outlook:
Tactical, Not Strategic, Changes Possible
• China appears willing to agree to some U.S. demands now
– Increased purchases of ag, energy and industrial products
– Unclear whether has agreed to lower auto tariffs
• China appears willing to negotiate on some issues
– IT, IPR protection, market access have all been noted
– China’s concessions are likely to be limited, without addressing the fundamental
issues of concern to the United States
• China is operating on a different timetable
– China likely views the next 90 days as the start of a dialogue, rather than a
deadline for completion
QUESTIONS & ANSWERS