U.S. Foreign Trade Zones: A Tariff Mitigation Strategy That’s Right For Your Business?

Recent changes in tariffs have business executives searching for how to best respond. Yet one potential solution has existed for over 90 years—and was adopted by Congress in the 1930s response to the last major trade war.  If you can qualify your business within a Foreign Trade Zone (“FTZ”) or utilize a service provider such as third party logistics provider that is located in an FTZ, you may qualify for deferred or reduced duty payments, while simultaneously making your supply chain more efficient materially reducing your U.S. Customs compliance costs, as well as a host of other benefits.

What is a Foreign Trade Zone?

A FTZ is an area that is physically located within the United States, but it’s considered outside the customs territory of the United States. Today, there are more than 260 FTZs in the United States, typically comprised of an area proximate (within 60 miles) of a port of entry. FTZs are designed to increase the use of American labor and increase capital investment in the United States by allowing activity to occur in the United States prior to application of U.S. customs laws, thereby equalizing the customs treatment of the activity to similar activities occurring offshore.

Authorized by the Foreign-Trade Zones Act of 1934 (the “Act”) FTZs operate pursuant to grants from the Foreign Trade Zones Board (“FTZ Board”). Operations are governed by the Act and by regulations issued by the Department of Commerce and the Department of Homeland Security, U.S. Customs and Border Protection.

Overview of FTZ Economic Benefits

FTZs were designed by Congress to provide benefits to both manufacturers and distributors. Because FTZs are considered outside of customs territory, businesses may import products into a zone without paying customs duties. Duties on products destined for domestic destination are deferred until products leave the zone. Products that are re-exported, either in original form or as part of a product made in a zone, are generally exempt from customs duties. With approval from the FTZ Board, a manufacturer may elect to pay duty on an imported component either at the duty rate applicable to the component or at the duty rate applicable to the finished product. In either case, U.S. value added in the zone is not subject to duty. Moreover, in an inverted tariff situation (where, as described further below) the duty on the finished product is lower than that on the imported component) manufacturing in a FTZ results in a lower overall duty to the manufacturer.

Operating in a FTZ also can provide significant administrative saving for a business. Many businesses recognize logistics and merchandise processing fee (MFP) savings through the special FTZ procedures for direct delivery of goods upon arrival and making weekly entries for good shipped into U.S. Commerce. With direct delivery, an importer may bypass normal customs clearance procedures and import a product directly into a FTZ. When product leaves the FTZ, FTZ users may also consolidate the reporting of all products shipped from the zone to domestic locations on a single weekly entry filed with CBP and pay a single MFP for the week. This results in streamlined compliance paperwork and can result in material administrative savings.

Operating in a FTZ can also result in state and local tax savings. For example, state and local ad valorem tax on inventory is not applicable to foreign origin or foreign destination goods held in a FTZ. In addition, some state licensing requirements are not applicable to companies operating in FTZ.

Specific Advantages of Operating in FTZs

The previous section provided an overview of the economic advantages for a business to locate in a FTZ, specific advantages can vary from company to company.

1.               Duty Deferral.

The universal benefit available to companies locating in a FTZ is the deferral of customs duties on imported merchandise. Imported merchandise is subject to duty upon entry into the U.S. customs territory, which normally coincides with the arrival of the merchandise in the United States. Because a FTZ is considered outside customs territory, however, merchandise that enters a zone is not subject to duty until it leaves the zone and enters domestic commerce. As long as foreign goods remain in the zone, they remain free from duty. Simply maintaining imported product inventory in a FTZ enhances the users cash flow, delaying the time that duty must be paid.

2.               No Duty on Re-exports.

As a corollary to the duty deferral rule, imported goods that are held in a zone and subsequently re-exported are not subject to duty at all. Companies that import and re-export merchandise, either in its original form or as components of finished products produced in a zone, receive this benefit. Please note, however, that this general rule has been modified for manufactured products leaving FTZs for Canada or Mexico as part of the U.S. Mexico-Canada Agreement, and the implications of that agreement should be carefully evaluated.

3.               Inverted Tariffs.

Tariffs under the harmonized tariff schedule of the United States, like most developed nations, generally assess higher tariffs on finished products than on raw materials or component parts. This is not always the case, however. There are a number of instances in which a particular component part of a specified item is subject to a higher duty rate than would be applicable to the completed item. This situation is called an inverted tariff.

Manufacturers or assemblers that produce completed products that are subject to an inverted tariff may find substantial savings by operating in FTZ. When imported goods are admitted into a FTZ, the importer generally can choose which of two tariffs rates will apply to the good by electing the status of either (a) the duty applicable to components at the time of admission to the zone, or (b) the rate that applies to finish products when they leave the zone into the customs territory of the United States. Moreover, if a business elects to pay duties at the rate applicable to the finished product at the time it leaves the FTZ, the value added to the product in the United States is generally excluded from the calculation of dutiable value.

4.               Supply Chain and MPF Benefit.

As noted above, FTZ users avoid customs clearance at ports of arrival and report zone withdrawals weekly, which can speed the supply chain. Many businesses benefit from the flexibility of customs procedures applicable to goods moving in and out of zones. For example, regulations provide for the direct delivery of merchandise into a zone with approval of the port director of U.S. Customs. Direct delivery can quite often eliminate delays from processing back ups at the port of arrival. Likewise, weekly entry procedures, which allow a single entry document combining zone shipping activity over a week’s period of time, are also allowed by regulation for manufacturing and distribution operations. Along with the administrative convenience, a single weekly entry is subject to the same cap on customs MFP as any other consumption. This can result in thousands of dollars of savings on customs entries.

5.               State and Local Tax Benefits

The Act specifically prohibits state and local governments from assessing personal property tax on inventory that has either been imported into a FTZ or is being held in a FTZ for export. This exemption applies only to inventory, not to equipment used in manufacturing, assessor to other for fixtures located in the zone.

6.               Obtain Domestic Identity.

Foreign components that are substantially transformed within a FTZ lose their identity as foreign merchandise for customs marketing purposes. This can be important from both a marketing standpoint and in situations where non-US products are subject to use restrictions. In certain circumstances, components imported into a FTZ can be transformed to qualify as goods “Made in America”, completely eliminating in the application of no duty those products leave the zone

7.               Rectifying Inadmissibility.

Goods not subject to importation into the United States may, in certain instances, be brought into a FTZ where the deficiency may be rectified. For example, merchandise not properly labeled or packaged for the U.S. market may be admitted to a zone and then relabeled or repackaged in a FTZ to conform to requirements of entry into domestic commerce.

8.               Scrap and Waste.

Importers of goods that through storage or processing generate scrap or waste may also benefit from FTZ status. While specific rules apply, as a general rule, the value of scrap or waste from imported components used to make a finished product can be deducted from the value of product on which duty is paid.

9.               Duty Drawback Acceleration.

A domestic manufacturer of a product with imported component may apply for drawback upon storing the finished product in a FTZ pending export. Domestic manufacturers also may ship defective components to a FTZ, where they may be destroyed but treated as exported for purposes of drawback. Both these scenarios accelerate the timeline by which a U.S. business may drawback duty on re-exported or destroyed products.

10.            Insurance.

Companies doing business in a FTZ can often reduce their inventory insurance cost. For insurance purposes, the insurable value of foreign goods in inventory includes the amount of duty paid. By storing foreign inventory in a zone, a business can reduce the insured value by the amount of duty that would have been paid and, accordingly, realize premium savings. Additional insurance savings so be realized due to the extra scrutiny and fire protection measures generally required in zones to satisfy U.S. Customs regulations.

11.            Quotas.

Following the concept that goods in a zone are outside the customs territory of the United States, import quotas are generally not applicable to goods stored in a FTZ. If an importer of products subject to a quota finds that he has and over-quota merchandise, it may store the merchandise in a FTZ rather than re-exporting the merchandise and subsequently bring the merchandise into domestic commerce of the United States during the next quota period. Importers who come across bargain purchases of over quota merchandise may similarly store the merchandise in a FTZ until there is availability under the quota to bring the merchandise into domestic commerce. As you can see, FTZ offer businesses flexibility and manage quota compliance and would allow companies to take advantage of discounts on over quota merchandise.

3PL Use of Foreign Trade Zones

Increasingly, sophisticated third party logistics companies are locating within FTZs to access the benefits described above for their customers. While these companies typically do not manufacture products, they often provide some packaging or assembly services. Moreover, even if they simply receive imported products within a FTZ and eventually ship the products to domestic customers, the duty deferral benefits of a 3PL operating in a FTZ can be passed along to their customers.

Obtaining FTZ Designation

Obviously, FTZs offer a wide range of benefits for manufacturers and distributors, as well as companies that utilize a 3PL to receive and distribute imported products. FTZs are typically located within 60 miles of a U.S. port of entry, and often within geographic designated zone established by a FTZ grantee, typically the port of entry. As noted above, there are currently over 260 FTZs in the United States.

All FTZs must be approved by the FTZ Board. Obtaining a geographic designation for your business also typically requires the support of the FTZ grantee. There are different methods of obtaining approval and the speed at which it obtained varies from 30 days to 10 months, depending upon the type of approval required by the zone in which you wish to locate.

As you might imagine, designation of your business as an FTZ site by the local grantee and the FTZ Board in Washington DC is only half of the approval process. The other half involves compliance with a range of CBP relations relating to the security and management of goods within the zone. This requires the use of quality inventory management systems, and involves high level inventory controls and detailed record keeping. A company operating in a FTZ must also post a customs bond, as it is responsible for payment of duty on all dutiable goods leaving the FTZ.

Therefore, while the benefits of FTZ operations can be substantial, a business should pursue FTZ designation with eyes wide open, knowing that it’s information technology systems, inventory system and attention to outgoing CBP compliance is essential. A business can face heavy fines if inventory located within a FTZ is mismanaged.

Conclusion

Looking back in history, the last time U.S. businesses faced tariff changes of the magnitude presently experienced was in the 1930s. Interestingly, the turmoil of the 1930s resulted in enactment of the Act, which was intended to provide economic benefits to United States manufacturers and distributors in the face of a changing tariff environment. Therefore, it makes sense that FTZs, since they were adopted in response to adverse effects on American manufacturers and distributors due to tariffs, may provide a helpful assist to U.S. businesses that are currently facing similar pressures.