the u.s.-china trade war: country of origin,...

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

[email protected]

Richard Mojica

Member, Miller & Chevalier Chartered

[email protected]

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


List 3 (July 10):

• $200 billion, 5,745 tariff

lines

• Wide range of

products, including

consumer goods


• 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


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


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



• 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



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


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


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 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 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 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 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


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


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 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


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

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