Both political parties have made promises around the return of manufacturing to the Unites States. Vote for them and this will be the certain result of their shrewd policies, so they say. Leaving aside the grandiosity of these promises, it highlights one of the few items on which each party seems to agree—that global supply chains and the outsourcing of American manufacturing are bad; so they say. Companies may want to take a closer look before making exciting plans for the opening of factories back in the Unites States. Look at what has actually been done by both parties and don’t listen as much to what they say.
When it comes to US government action since 2008, it is clear that maintaining global supply chains rather than re-shoring is what government action has incentivized. US Tax reform has fit hand-in-glove with long standing trade customs and tax regulatory provisions to continue to incentivize imports and the substantial benefits of global supply chains and corporate services. In making strategic decision, let’s highlight the key US government actions that should be informing such decisions rather than following empty rhetoric.
US Tax Reform BEATs hollow policy statements
To simplify an otherwise complex aspect of the Tax Cuts and Jobs Act, this massive overhaul of the US code incorporates a new tax–the BEAT, which is a minimum 10% tax (increasing to 12.5% in 2025) on certain base erosion payments made by US corporate taxpayers to related entities. Such basis erosion payments include, royalties and interest payments amongst other items. These payments have also been highlighted by the OECD and member-state tax authorities as being part and parcel to “abusive” tax planning structures utilised by multinational corporations in order to accrue profit offshore where tax rates, or net effective tax rates may be lower or even nil in the extreme. While the BEAT appears to be an attempt to address payments to related foreign persons, it actually carves out an enormous exception to the BEAT, which functions to incentivize such payments rather than tax them.
Specifically, in defining base erosion payments, Congress affirmatively excluded payments for costs of goods sold. See, H. Rpt 115-466, p. 657 (stating “base erosion payments do not include… payments for cost of goods sold.”). As a result, payments made or accrued to a related foreign person through costs of goods of sold are not subject to BEAT. This exclusion from the BEAT is significant. Multinationals with global supply chains often have sourcing offices, design centers, intellectual property held in offshore entities, and shared service centers located in various jurisdictions for commercial reasons well as for cost and tax efficiency. These multinational taxpayers can consider allocating qualifying royalties on sales as well as certain proportions of group accounting services and sourcing services to COGS and thus not be subject to BEAT at all.
“Return supply chains to America” they say, while incentivizing the continued, or even increased, offshoring of such supply chains. Strategic supply chain, manufacturing and sourcing planning should focus on the specifics of the actions taken and the interpretations articulated rather than on the policy statements made in public fora.
Tariffs are no barrier to Trade
The US helped to usher in a new era of trade protectionism with the imposition of tariffs on Canada, China, the European Union, Mexico, and soon to be Vietnam. The sales pitch for these tariffs is that they would either protect national security or boost American domestic manufacturing by saddling foreign exporters with additional costs—or both.
First off, we all know that it is the importer into the United States that pays for the tariffs. It is therefore the customer and not the exporter seller that pays for the tariffs. These tariffs paid for by the US importer are typically assessed on the basis of the value of the imported merchandise. Thus, the basis for determining the duty liability is the declared value of the imported goods. In this regard, it is axiomatic under US tax law that costs of inventory imported from related parties must agree with the values reported to US Customs and Border Protection for that inventory. See, 26 U.S.C. § 1059A. Much of the volume of US imports are by and between related parties.
Thus, tariff increases on these imports made by multinationals from their overseas group companies, and for which the transfer prices may include certain costs that may otherwise be non-dutiable as part of COGS as discussed above, could result in increased customs duty upon import; right? Should it even matter since, as the US government says, the foreign exporters bear the burden of these tariffs? Again, looking at what US Customs and Border Protection (“CBP”) as well as what the Internal Revenue Service (“IRS”) actually do is more instructive than what the administration says on policy matters.
In making their declaration, US importers need not declare and pay duty upon the highest value in the supply chain that lead to the ultimate US import, which may often be the last sale leading to the import. Rather, US customs valuation rules enable importers to declare the first sale in the supply chain that was a qualifying sale for export to the United States. This first sale may often be the lowest value in the supply chain leading to the ultimate import into the United States. More importantly, this first sale, provided it qualifies as a valid transaction value for CBP purposes, will also exclude additional costs that may be capitalised within the COGS between related parties further down the supply chain. As a result, by utilising this “first Sale for Export” valuation methodology, the value declared to CBP may therefore be significantly lower than the costs of the inventory on related party transactions.
This lower value declared to CBP as compared to the higher COGS reported to the IRS appears to violate 1059A; right? Here again, the IRS rides to the rescue of multinational corporations and global supply chains and reconciles the apparent conflict. In addressing the apparent conflict for taxpayers who choose to take advantage of the First Sale for Export valuation methodology with CBP, the IRS Office of the Chief Counsel drew an analogy to other non-dutiable costs that may be a part of the transfer price of inventory for tax purposes citing to Treas. Reg. § 1.1059A-1(c)(2). In so doing, the IRS Chief Counsel therefore concluded that “an adjustment under section 1059A with respect to a value differential that results solely from an importers correct application of the first sale rule and subsequent real value added under Treas. Reg. § 1.1059A-1(c)(2) is not proper.” In other words, the IRS Chief Counsel recognised that customs valuation is different from transfer price and where that difference is due to clear CBP precedent such as first sale for export, the two need not reconcile.
They say tariffs will increase duty costs which are born by the foreign exporters, incentivising a return of supply chains to the Unites States. In fact, US tax and customs regulations provide for ample space for duty and tax efficiency in the global supply chain. The IRS further accommodates such structures. In concert, the two facilitate the exclusion from the BEAT for certain payments made to foreign related persons under the TCJA. Don’t be fooled by policy statements when making strategic decisions for the future of your company’s manufacturing and supply chains.
E-Commerce Isn’t Fulfilling
Certainly, one of the bright lights in the US retail industry has been e-commerce. The growth in this sector has outpaced traditional retail by a significant margin. This e-commerce growth has been dominated by large US companies such as Amazon.com and Walmart amongst others. Although the merchandise being sold may not all be made in the US, certainly the government’s policy of incentivising job creation in the US will at least keep the fulfilment operations within the US; right? Once again, when making strategic planning decisions, do not listen to what the government says with respect to policy. Rather, look at what they have done legislatively and administratively. In this regard, once again, the incentives remain to globalise the e-commerce fulfilment operations as much as practicable.
Section 321 of the Tariff Act of 1930 permits imports by one person on one day that are valued up to US$800 (as of the time of this writing) to be imported without an ordinary entry summary declaration or duty and tax payments to CBP. International companies have utilized Section 321 at an increasing rate to import a variety of consumer goods into the United States from various countries of origin, including China. Of course, certain goods of Chinese origin that are imported into the United States may be subject to additional duties pursuant to the US Section 301 tariff measures; right?
Here too, CBP has provided a wide lane. Specifically, CBP has clarified that such additional duties would not be applicable to imports made under Section 321. See, U.S. CUSTOMS AND BORDER PROTECTION SECTION 301 TRADE REMEDIES FREQUENTLY ASKED QUESTIONS (last accessed July 8, 2019). For multinational e-commerce companies, this means that fulfilling relatively low value individual e-commerce orders from outside the customs territory of the United states provides duty and tax efficiencies that cannot be gained from doing so within the customs territory of the United States. Consequently, the consumer goods supply chain remains affirmatively global primarily by action of law and CBP practice rather than contradictory policy statement from the US government.
Pandemic Support for Global Supply Chains
The dissonance we see between the “re-shoring” policy statements and the affirmatively global nature of tax and customs law, regulation and interpretation should not be surprising. What may surprise you though is that US government bail-out packages issued in response to the economic shocks caused by the COVID-19 pandemic may have been subsidies to global supply chains and offshore manufacturing.
Just this week, on October 29, the U.S. Bureau of Economic Analysis released US GDP growth for the 3rd quarter of 2020. The report shows that from the first week of August 2020 there is significant growth in consumer spending in the United States as compared to 2019 in year-on-year comparisons. Many economists attribute this growth in consumer goods purchases to the trillions of dollars in stimulus money distributed to individuals by the US Treasury Department. The stimulus funds, therefore, directly resulted in an increase in consumer spending. Where did those goods come from? You’re right! They were imported.
The Bureau of Economic Analysis shows an almost 108% annualised increase in goods imports for the third quarter of 2020. China, as a counter example, recently reported its third quarter trade data as hitting a historic quarterly high with exports jumping over 10%. Both countries issued substantial economic styimulus money to support their respective economies in light of the pandemic. The policy actions of each country can be distinguished on the basis of where their stimulus money was sent. The US Treasury Department put relief payments in the hands of individuals who purchased the goods they need from the established global supply chains that have always been supplying them. China supported its corporate entities, the producers that have long supplied these consumer goods to overseas markets, including the United States.
This appears as though Us government stimulus money went to Chinese exporters via the hands of individual American consumers. This is a far cry from supporting US domestic manufacturing and the re-shoring of supply chains in response to the pandemic shock as was the stated policy objective.
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There is no doubt that trade disputes, global economic shocks, and tax reform in the US has motivated companies to closely examine their strategic direction regarding their manufacturing, sourcing, and distribution activities. Given aggressive policy statements from the Trump Administration as well as campaign promises from the Biden campaign, it would be understandable that many companies may conclude that it is re-shoring their supply chains that should be in the strategic plan. Based on the objective facts, a different conclusion may actually be warranted. The key takeaway here is that government policy statements are not trustworthy decision-making tools. In other words, so as they do and not as they say when planning your global supply chain restructuring.