Business Guide to Tax Evasion -- relax...it's perfectly legal!
Companies can avoid import duties and other fees by shipping through and manufacturing in a Foreign Trade Zone.
Goods that offer value to American manufacturers can be found the world over. But importing and distributing them, or using them to manufacture products, incurs a myriad of trade-related costs—from taxes to administrative fees imposed by U.S. Customs & Border Protection (CBP).
How can global companies realize the benefits of importing goods without carrying the financial burden associated with foreign trade? By bringing goods into the country without bringing them into the country.
If that sounds like exploiting a legal technicality, that's the idea. The technicality is known as a foreign trade zone (FTZ), and using it to avoid paying duties and fees is exactly what was intended when FTZs were created in the 1930s.
When imported goods make their first stop in a designated foreign trade zone, they have not yet entered the country as far as U.S. import law is concerned—even if they traveled by truck from a port in California to an industrial park in Columbus, Ohio.
Goods brought into the country via an FTZ can be used in manufacturing, and can be assembled, tested, repackaged, warehoused, processed, relabeled, and manipulated in a variety of ways. They can even change form completely. As long as they stay inside the FTZ, they are not subject to any import duties.
The National Association of Foreign Trade Zones reports receipts into FTZs totaled $495 billion in 2006—the last year in which complete records are available, according to Will Berry, the group's executive director. That represented an increase of approximately $100 billion compared to 2005.
"That's big money," Berry says. "Some of the growth can be attributed to oil prices, but there is also growth in non-oil products. Many states don't have oil refineries, yet FTZ trade volumes still show growth."
Jobs associated with FTZs also grew from approximately 25,000 to 30,000 between 2005 and 2006, Berry notes.
While the recent economic downturn may stunt global trade activity, it may also serve as an opportunity for FTZs, which offer a variety of cost-saving strategies and value-added services.
"Foreign trade zones offer logistics efficiencies not found in other import processes," Berry says. "Goods move through FTZs quickly, thanks to special procedures."
FTZs are chartered by governmental entities or regional authorities, and they typically hire private sector operators—often third-party logistics providers (3PLs) or other organizations experienced in importing, shipping, and warehousing.
Penrod-Ricard USA, a Purchase, N.Y.-based wholesaler of wine and spirits, manufactures goods in the United States and imports many products from abroad. The company uses two FTZs: one in Baltimore, Md., primarily for import activity and one in Oakland, Calif., primarily for export activity.
"We import our value-added packaging, which could include elaborate glasses or cartons, through the FTZs," notes David Throckmorton, Penrod- Ricard USA's director of logistics.
FTZ rules allow Penrod-Ricard to import the packaging with the product to avoid paying separate excise taxes.
"We bring the spirits and packaging into the Baltimore FTZ, and when we pull them out of the foreign trade zone, we're responsible for only one excise tax," says Throckmorton. "We avoid paying the duty fees, which can be significant, on the glassware."
This technique is legal provided the packaging is involved in the consumption of the product. That's why a glass qualifies, for example, but a wooden crate does not.
During a typical holiday season, use of an FTZ saves Penrod-Ricard between $100,000 and $250,000 in excise taxes, Throckmorton estimates.
Penrod-Ricard uses the Oakland FTZ for duty-free export activities. By sending goods bound for global destinations through the FTZ, the company avoids excise taxes that could amount to nearly $30 per case or $1.50 per glass.
The mainstay of an FTZ's appeal is its ability to shield importers from the burden of paying duties. Goods do have to leave the FTZ eventually, and at that point applicable duties are assessed. But FTZ operators argue that even if a company ends up paying the full duty, it still benefits from moving goods through the zone.
"It's strictly a time versus value-of-money comparison," says John Zevalkink, CEO of Columbian Logistics Network, Grand Rapids, Mich., which operates the Kent Ottawa Muskegon (KOM) FTZ in western Michigan.
"If companies can avoid paying the duty before they pull product into a zone—and it might take one week from the time a container is off-loaded at the port and transported to an inland zone—they save money while the product is in transit," he notes. "The amount could be substantial."
In addition, companies can combine duty deferrals with inventory cycles to help reduce costs.
"Suppose a company turns inventory 12 times a year," Zevalkink says. "If it doesn't have to pull products out of the FTZ immediately, it might gain an additional month of duty savings by holding the product in inventory before it has to be used."
THE WHOLE IS CHEAPER THAN THE SUM OF ITS PARTS
But FTZs also make it possible to eliminate the duty entirely. The key is to manufacture the imported parts or pieces into a final product before shipping them out of the FTZ.
"This is common practice among drug manufacturers," Zevalkink notes. "They pay a duty on the raw ingredients. But, once most prescription or over-the-counter drugs take the form of a pill, paying duty fees is not required."
To take advantage of that aspect of trade law, many manufacturers set up specific operations in FTZ sub-zones, and produce their goods on-site. An FTZ sub-zone can be situated anywhere the designation is approved.
The KOM FTZ was originally established with a primary sub-zone occupied by now-defunct Bosch Automation. Bosch was located approximately 12 miles from the KOM FTZ in downtown Grand Rapids, but as long as goods traveled back and forth between the two locations in bonded transport approved for FTZ-related use, they had still not yet entered the country as far as the law was concerned, according to Zevalkink.
Avoiding duties by manufacturing on-site is the most common benefit for FTZ users, notes Linda Hothem, former owner of and current advisor to Oakland, Calif.-based Pacific American Services, which operates an FTZ out of the Port of Oakland.
"Manufacturers pay a lower duty rate on the finished product than on the parts combined," Hothem says. "That comprises the bulk of the savings."
FTZs also allow manufacturing and assembly to occur in the United States under circumstances in which a duty will never be paid, adds Geoff Manack, co-owner of Hyperlogistics Group, a 3PL that operates an FTZ in Columbus, Ohio.
"Take a company that imports fabric from China, then ships finished garments to Europe or South America through a U.S.-based FTZ," Manack says. "According to FTZ rules the goods never entered the United States, so the importer does not have to pay the duty."
Recent growth in FTZ interest is not just about avoiding duty payments; it's also about reducing administrative fees imposed by CBP, particularly merchandise process fees—payment owed to customs brokers who bring goods into the United States on behalf of clients.
Recent changes in the law have made it possible for importers to significantly reduce their liability for these fees, but it requires the kind of volume that would be hard to achieve without an FTZ, according to Berry.
"Companies can do weekly entry—bringing all their goods into an FTZ once in a seven-day period," Berry says. "By doing that, they pay only one merchandise processing fee and generate one document. That is a huge cost saver."
CBP also allows goods brought into an FTZ sub-zone to move straight into the assembly line without stopping for paperwork.
"Companies that run 24/7 operations can bring merchandise into an FTZ, and file CBP paperwork the next day so they don't have to stop a line," Berry says. "But not every company qualifies, and it requires CBP approval."
The new CBP rules are especially helpful to major importers.
"The rules allow FTZ users to pay one merchandise processing fee for all the goods they receive within a week," Zevalkink says. "Because major importers generate thousands of purchase orders annually, these savings can be substantial."
The emphasis on national security after 9/11 has also contributed to the growth in FTZ use.
"FTZs are especially well-suited to help companies participate in secure trade," Zevalkink says. "FTZs have to carry a bond that ensures they are providing security services, and they have to submit to FBI background checks."
Security at the KOM FTZ is the responsibility of Bill Ekberg, director of operations for Columbian Logistics Network. He oversees an elaborate security system comprised of 40 video cameras cataloging 45 days of archives, microwave motion detectors, and panic buttons at the only two doors that provide entry into the facility.
"The crown jewel of this security system is a portable wireless camera," Ekberg says. "We can put it anywhere in the warehouse if we suspect a problem."
Prospective employees are subject to extensive background checks. Columbian Logistics even calls their high schools to confirm that their diplomas and transcripts are legitimate. "They know coming in the door that this is a secure operation," Ekberg says.
PATCHING THE LEGISLATIVE HOLES
To streamline the process of moving goods, the federal government gives FTZs the opportunity to receive C-TPAT certification. Those who qualify must meet a set of important security standards that allows them to expedite the Customs inspection process.
While Hothem believes C-TPAT certification is crucial, she objects to the fact that—at least for now—only port-based FTZs qualify, and inland FTZs do not.
"Just because a container arrives in the Port of Los Angeles doesn't mean it has been opened," Hothem says. "The point at which it's first opened—when the seal is broken and the handle on the door is unlocked—should be included in the security sequence. To assume that once it gets to the port all potential security risks have been eliminated is inviting trouble."
FTZ operators are also pushing for another legislative change—one that would correct an anomaly in NAFTA that subjects a product assembled in Mexico to less duty than one assembled within a U.S.-based FTZ.
"The proposed legislation would allow free trade agreement status for FTZs located in the United States," Hothem says. "Within a year after the NAFTA agreement was signed, Canada and Mexico eliminated duties to foreign importers. So companies could bring in parts from Asia, assemble them in Mexico, and bring them into the United States duty-free.
"But if they brought those same parts from Asia into a U.S. FTZ, and assembled them into a television, for example, they would pay a duty as if it were manufactured in Asia," she adds. "That just doesn't seem fair."
Legislative issues aside, FTZs offer many benefits to importers and exporters, not the least of which is the ability to participate in legal tax evasion.
WTFTZ? FAQs About FTZs
What is an FTZ?
An FTZ is an area within the United States, in or near a U.S. Customs port of entry, where foreign and domestic merchandise is considered to be outside the country, or at least, outside of U.S. Customs territory. Certain types of merchandise can be imported into an FTZ without going through formal Customs entry procedures or paying import duties. Customs duties and excise taxes are due only at the time of transfer from the FTZ for U.S. consumption. If the merchandise never enters the U.S. commerce, then no duties or taxes are paid on those items.
What activities are permitted in a Foreign Trade Zone?
Merchandise entering an FTZ may be:
*The user must receive special approval from the FTZ Board.
What are the benefits of operating within an FTZ?
- Deferral, reduction, and possible elimination of duties.
- Tighter inventory control that may virtually eliminate year-end inventory loss adjustments.
- Potential direct delivery benefit reduces long hold times at crowded ports of entry.
Why do companies use foreign trade zones?
To maintain the cost competitiveness of their U.S.-based operations as compared to foreign-based competitors. For a company, zone status provides an opportunity to reduce certain operating costs associated with a U.S. location that are avoided when operating from a foreign site.
How does the U.S. FTZ program fit within the economic development efforts of the various States?
It is a federal program so the underlying authority to approve the creation of a foreign trade zone resides with the federal government. Every state, however, has enabling legislation providing statutory authority for the establishment of FTZs. The creation and development of individual zone projects typically result from a combination of interests generated by both the private and public sectors. The Foreign-Trade Zones Board Staff advises zone organizers to integrate the zone project into the state or local area's overall economic development strategy rather than segmenting the zone as an individual development effort. In this way, FTZs complement other state and local incentives that are incorporated into the overall efforts of a community to maintain their attractiveness as a business location.
Is zone status more beneficial to foreign-owned companies than it is to American-owned companies?
The benefit of zone use is determined by the location of a company's operations in the United States, not by its ownership. If an American-owned company and a foreign-owned company have identical trade operations, the potential benefits for each of them are identical. The U.S. FTZ program encourages investment and production in the United States that might otherwise take place in another country.
Does the cost reduction feature of zone status translate into an import subsidy or a cause of imports?
The reverse is true; the increasing importance of international trade in the U.S. economy has caused a corresponding increase in the use of zones. Periodically, oversight agencies such as the International Trade Commission and the General Accounting Office examine the impact of the U.S. Foreign Trade Zones program. These periodic reviews have not produced any information leading to the conclusion that zones cause imports. The decision to import precedes the decision to use zones.
How do zones "expedite and encourage" direct foreign investment in the United States?
The United States welcomes foreign investment but does nothing to overtly attract or discourage it. Through the policy of "National Treatment," foreign investors are offered the same conditions, rights, and benefits associated with investing in the United States as an American investor can expect to receive. In keeping with this policy, zones encourage foreign and domestic investment by removing a tariff bias that unintentionally discourages investment in the United States and encourages supplying the U.S. market from off-shore.
Are there any practical or economic limits to the number and uses of zones?
For the foreseeable future, there are no economic limits to the use of zones. As the U.S. economy becomes even more internationalized, and as markets become globally homogenous, the operational flexibility and other benefits for which zones are used will motivate a commensurate increase in zone use. As a practical matter, the limits on the number of zones are a function of the number of U.S. Customs ports of entry and the individual communities adjacent to them.
Is the maintenance of the FTZ program costly to the United States?
The establishment and maintenance of FTZs require a minimal expenditure of federal tax dollars. The cost of processing applications by the Foreign Trade Zones Board is offset by application fees and the cost of processing FTZ merchandise by the U.S. Customs Service is offset by merchandise processing fees. Therefore, foreign-trade zones are a self-sustaining tool of international commerce offering significant benefits to U.S. industry and aiding the U.S. balance of trade.
SOURCE: National Association of Foreign Trade Zones