Trade wars and Section 301 tariffs: Practical mitigation strategies for Canadian companies

Trade wars and Section 301 tariffs: Practical mitigation strategies for Canadian companies

Original article: https://www.edc.ca/en/blog/trade-wars-section-301-tariffs.html

Quick timeline of the recent U.S.-China trade tensions

Beginning in June 2018, the U.S. government has taken trade actions against more than $550 billion worth of commodities originating in China based on a Section 301 investigation delivered to President Donald Trump from the U.S. Trade Representative (USTR). The USTR investigation into China determined that it was unreasonable and discriminatory in its acts, policies, and practices relating to technology transfer, intellectual property, and innovation in a manner that harms American intellectual property rights, innovation, and technology. 

As a result, trade countermeasures (China-specific tariffs) have been applied by the U.S. government over the course of several rounds. The first three rounds were in June, August, and September 2018, with an aggregate annual trade value of approximately $250 billion, by increasing the rate of additional duty from 10% to 25% (to see them, click on lists 1, 2 and 3 on the left of the linked page). These rounds were followed by the most recent $300 billion trade action (list 4), that partially came into force Sept. 1, 2019 for a portion of the List, and on Dec 1, 2019 for the remaining portion. 

The following resources can help you stay up-to-date with the U.S. trade actions against China and determine if your Chinese imports into the U.S. are affected:

So what? My business is Canadian

As a Canadian company, with a mostly North American supply base, why should you care about the U.S.-China trade action? For starters, most of Canada’s export business relies on integrated North American supply chains—especially if your business sources from China come directly, or indirectly through the United States. In either case, you might be impacted by the recent U.S.-China trade tensions. For example, an EDC customer was recently interested in importing polyethylene film from China to Canada, converting it into a higher value product with a special coating in Canada and selling it to the U.S. Great idea, right? Unfortunately, there are high duties on Chinese imports to the U.S. right now, and despite substantially changing the product in Canada through a value-added activity, the customer was concerned with the ultimate duty applied to the final product (the China duty rate or the NAFTA free trade tariff rate)? 

If you’re a Canadian small business owner or entrepreneur, we urge you to consider the following:
 

Supply chain 360: Take stock of your exposure to tariff risk

Instead of finding out about a supplier issue from your shipping team or worse, customs proactively assess your current supplier relationships—both direct and in-direct (i.e. sub-suppliers from a trade disruption perspective). Knowing where you are exposed to risk is the first step in mitigating. 

To narrow your analysis, Canadian companies concerned with the Section 301 duties applied by the USTR should review the published lists (for both U.S. customs and Canada—keeping in mind that HS codes are consistent internationally up to six digits and then vary by country. It’s always helpful to ensure that the HS codes previously applied to the product that you import directly from the U.S. are still accurate (especially if they’re the codes that fall into the USTR published lists). If you aren’t sure about the HS codes applicable to certain imported components, we urge you to speak with your customs broker. 

Consider the product exclusion process

In imposing Section 301 duties against specific Chinese origin products, the USTR also created a process by which American importers and other interested parties could petition for the exclusion of their specific products. Some factors that USTR considers when reviewing petitions from interested parties include:

  • Is the product only available from China? Are comparable products available in the U.S.?
  • Does the imposition of additional duties cause severe economic harm to the particular importer or party requesting the exclusion? 
  • Can the U.S. Customs and Border Protection (U.S. CBP) administer the exclusion of a particular product?

So far, several batches of exclusions have been granted for items from lists 1, 2 and 3. The exclusion requests process for list 4A began on Oct. 31, 2019 and the first batch of exclusions for this list is expected in early 2020. The good news is that all importers can take advantage of these exclusions—not just the ones who submitted the petitions. This means that the HS codes listed in the exclusions notes are exempt from the 15 or 25% additional ad valorem duty and can be imported under a regular rate of duty as listed in the U.S. Tariff Schedule. 

Each batch of exclusions, however, will extend for just one year from the date it was published. Nevertheless, it still provides significant relief from high tariffs for a large number of goods and can save companies a lot of money.

The USTR page on the China Section 301-Tariff Actions and Exclusion Process provides the most up-to-date information on the exclusions process. You can review exclusions granted under each list by navigating each Trade Action’s page (e.g. $34 Billion Trade Action (list 1),  under $34 Billion Product Exclusion Process see the list of Exclusions Granted by date) of the USTR website.

To seek remedy under the USTR exclusion process, we recommend speaking with a Canadian or U.S.- based trade lawyer. 

Redirecting shipments to Canada

If you ship some of your goods directly from China to the U.S. for further distribution in the United States through a third-party logistics provider, odds are your imports from China will be subject to Section 301 tariffs. It’s common practice to use third-party logistics providers in the U.S. to fulfill orders and deliver products to the consumers in the U.S. faster, instead of shipping them to a warehouse in Canada first and then to the U.S. 

However, you may want to reconsider your supply chain structure and choose to ship goods from China to Canada first, if you want to avoid paying high Section 301 tariffs on Chinese imports. Redirecting shipments of Chinese goods in big quantities into Canada, and then fulfilling orders to U.S. consumers from Canada by shipping small orders (valued at US$800 or less) from Canada directly to the consumers in the U.S. Such orders satisfy the U.S. de minimis (Section 321) value threshold and therefore, are free from duties and taxes, as long as the shipment is imported by one person per day. While the $800 threshold may sound insignificant, it can save companies, especially online retailers, a lot of money.  For example, if they’re using a sophisticated e-commerce system, they can apply the de minimis theoretically to an unlimited number of products, as long as they’re all being shipped to different online customers. Same-day delivery, however, won’t be an option in most cases under this strategy, since the goods will be shipped from Canada. We acknowledge  that this strategy is not well-suited for B2B shipping or reselling, since it’s limited to $800 per package. 

The duties that Canada collected on Chinese imports can be recovered through the duty-deferral program

Some Canadian third-party logistics providers have already started offering services, which allow firms to redirect their shipments of Chinese goods to Canada. 

Watch for illegal transshipments

Problems may arise when companies use illegal transshipments—when you ship through a third country to conceal the true origin of goods—to avoid paying tariffs. For example, Chinese goods destined for the U.S. are shipped first to a third country such as Malaysia or Canada that has a free trade agreement with the U.S. In that third country, a local company takes possession of the goods and forwards them to the United States, claiming them as being the origin of this third country—not China. 

American and Canadian customs are aware of this workaround and collaborate together to detect and avoid such transshipments. Companies exporting goods of Chinese origin to the U.S. through illegal transshipments will face penalties if detected.
 

Third-country assembly: Minimal processing vs. substantial transformation 

Another scheme commonly used by companies to avoid high tariffs is assembly or product modification (value addition) in a third country. This is when transnational corporations import semi-finished goods from China to assemble them, for example in Canada, into a finished product. They then label them as “Made in Canada” to take advantage of the duty-free treatment under the North American Free Trade Agreement (NAFTA) for most goods imported from Canada. However, exporters need to be aware that products of third countries, like China, being transshipped through or undergoing only minor modifications in the NAFTA territory aren’t eligible for preferential tariff treatment if they don’t meet the rules of origin requirements under NAFTA. Instead, these imports will be subject to regular duty rate (Most-Favored-Nation (MFN)), and in case of articles from China—subject to additional Section 301 tariffs.

The rules of origin under NAFTA are already complex enough, and one cannot make assumptions without a careful reading of the rules. Determining the country of origin for the purpose of Section 301 duties becomes even more troublesome. 

There are different criterions used to determine the origin of products to qualify for NAFTA treatment. NAFTA Annex 401 lists product-specific rule of origin requirements and these rules vary depending on HS codes. For example, a product can qualify as originating if it satisfies a specific tariff shift (HS code shift), or if it satisfies a tariff shift and regional value content requirement (RVC), or if it satisfies a regional value content requirement with no tariff shift. 

However, for the purpose of Section 301 tariffs, the U.S. uses different tests to determine the country of origin that serve different purposes. In addition to the NAFTA Rules of Origin, the U.S. also uses  the one called a “substantial transformation” test. It examines the totality of circumstances surrounding the manufacturing or assembly process to determine whether a manufacturing or assembly operation results in a “substantial transformation” of a final product. A good example can be found in Headquarters Ruling H300226 (Sept. 13, 2018) in relation to product assembly in Mexico, when CBP concluded that, while the NAFTA Marking Rules (19 C.F.R. Part 102) are used to determine the country of origin of articles imported into the U.S. from Mexico for marking purposes, the traditional substantial transformation test is used to determine the country of origin of articles for Section 301 duty purposes. In other words, in relation to assembly in Canada, a product marked as “Product of Canada” can be subject to duties applicable to “Products of China”. 

The main conclusion from this ruling is that if you’re looking to avoid Section 301 tariffs by shifting production or assembly to Canada, you need to make sure that your operations not only satisfy the rule of origin under NAFTA, but also result in a substantial transformation of a final product. A customs broker or a trade lawyer can help you determine whether your final products would qualify.

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