Most customs duties such as ordinary duties applicable to specific tariff headings, antidumping duties and countervailing duties applicable to certain merchandise from particular countries of origin, as well as duties collected pursuant to other trade remedies such those imposed in the US-China Trade War, are charged on an ad valorem basis—or as a percentage of the value of the imported merchandise.

Therefore, underreporting the value of imported merchandise will unlawfully reduce the calculation of duties payable pursuant to undervalued imported merchandise.  For many of these duty categories, the rates may be 15%, 25%, or as high as 300% or more of the value of the imported merchandise.

Undervaluation can take on many forms:

A. Double invoicing

One invoice presented to customs for the calculation of duties and another invoice presented to the importer, which is payable to the overseas seller by the importer for the imported merchandise. This is the classic example of customs fraud.

B. Undervaluation resulting from related party sales prices that are not set at arm’s length

Many importers are related to the overseas sellers from which they import merchandise into the United States. Since these parties are often within the same corporate group or otherwise under common control, the sales prices set between the overseas exporter and the US importer are often not at arm’s length within the meaning of the US customs laws.  In fact, many times these prices are not set by any objective standard at all other than how much duties and taxes an importer is willing pay—typically orders of magnitude lower than those lawfully owed.

C. Unsubstantiated “first-sale” claims

US customs law allows importers to properly value their imports using the price set on the first sale for export to the United States. That so called first sale is usually further upstream in the supply chain and excludes certain costs and profits of a middleman trading company that may be involved in the import transaction.  While this structure may be generally lawful, it has conditions that must be met such as, among other conditions, the first sale value must be an arm’s length value that is free from any distortions that may result from a relationship between the first sale seller and the middleman trading company.  Many (if not most) middlemen trading companies are related to the factories producing the goods they sell overseas.  Moreover, these related overseas parties often set transaction values amongst themselves based on local duty, tax and indirect tax considerations and not based on arm’s length valuation principles.  Importers who knowingly or negligently use a first sale value that has not be properly reviewed and qualified as arm’s length under US customs laws may be committing customs fraud.

D. Splitting royalties and license fees from the value of imported merchandise

Royalties are generally dutiable where there are BOTH related to the imported merchandise (e.g., a trademark royalty for a trademark applied to imported footwear) AND paid as a condition of the sale for import (i.e., the importer cannot purchase this branded merchandise without payment of the brand licensee fee or trademark royalty).  Where such dutiable royalties apply, a common fraudulent scheme to avoid the payment of duties on these royalties is to pay these royalties under a separate invoice, one that is not associated with the imported physical merchandise.  In many cases, such split invoices for royalties result in unlawful duty avoidance.

There are nearly as many undervaluation schemes as there are importers.  These are merely some of the more common—the well-worn path if you will.

Imported merchandise must be categorized or classified under one of the 10-digit tariff subheadings in the Harmonized Tariff Schedule of the United States.  The applicable tariff subheading, along with the country of origin, will generally determine the duty rate applicable to the imported merchandise.  In addition, the tariff subheading, along with the country of origin, may also determine the applicability of antidumping or countervailing duties, US Section 301 duties in the US-China trade war, or the applicability of other trade remedies.  As is obvious, inappropriate tariff classifications can often result in unlawful avoidance of duties, both ordinary and trade remedy duties.

Tariff classification is a complex and technical area of the customs law.  Therefore, customs fraud related to misclassification would most clearly be shown by using subheadings entirely unrelated to the imported merchandise, those with zero duty rates attached to them, or those outside the scope of applicable trade remedies where the more obviously applicable subheadings would be subjected to such additional duties.  In such cases, and in the absence of a customs opinion or professional advice, importers may well be engaged in customs fraud.

As discussed above, the country of origin, along with the applicable tariff subheading, will determine the duty rate applicable to imported merchandise and will also determine the applicability of any additional duties pursuant to trade remedies such as antidumping duties, countervailing duties, and Section 301 duties under the US-China Trade War.  In addition, country of origin also determines the admissibility of imported merchandise.  For example, merchandise of Cuban origin is generally subject to an embargo in the United States and may not be imported.

In addition, country of origin may also determine the applicability of free trade benefits under one if the US’s many free trade agreements or a multilateral agreement such as the Generalized System of Preferences for lesser-developed countries.  As a result, there are many motivations for making fraudulent origin claims.

The country of origin of an imported product is broadly defined as the country of manufacture, production, or growth of any article of foreign origin entering the customs territory of the United States.  In the modern supply chain, this definition is not particularly helpful.  In fact, inaccurate declaration as to the origin of imported merchandise is much easier to make than one may otherwise believe.  There is no specific statutory provision for customs “rules of origin” or “country of origin” under US law.  Rather, US CBP looks to court precedent, CBP regulations, and agency interpretations to determine origin of an imported product where necessary.

Rules of Origin under WTO

There are two operative sets of rules of origin (ROO): (1) Non-preferential ROO; and (2) preferential ROO, which are used to determine eligibility for tariff preferences under trade agreements to which the US is a party.   With respect to non-preferential ROO, these are the rules used to determine the origin of goods imported from countries with which the United States has most-favored-nation (MFN) status (i.e., WTO member-states).  These non-preferential ROO are the primary basis of the assessment of tariffs on imports, addressing country of origin labeling issues, and determining admissibility of merchandise., as discussed above.

Under non-preferential rules of origin, two major criteria apply. First, goods that are wholly the growth, product, or manufacture of one particular country are attributed to that country. This is known as the wholly obtained principle and is quite straight forward. Second, and by far the most common scenario in the modern supply chain, where an imported product consists of components from more than one country, a principle known as substantial transformation is used to determine origin. In most cases, the origin of the goods is determined to be the last place in which a substantial transformation occurred resulting in a new and distinct article of commerce based on a change in name, character, or use.

It is plain to see that this standard is subjective and not intuitive for the layman in making their own determination about what constitutes a change sufficient for conferring origin.  Origin determinations are fact-specific and even CBP acknowledges that there can be considerable uncertainty about what is deemed to be substantial transformation due to the “inherently subjective nature” that may be involved in CBP interpretations of these facts.

Global trade and manufacturing are increasingly cross border, involving design, production, marketing, distribution, support, and delivery to the final consumer, with each of these steps potentially occurring within different jurisdictions.  Moreover, there is an increasing reliance on outsourcing parts of the production to sub-contractors that may themselves be located in a third country.

Even where an importer seeks the clarity of a ruling from CBP, the issuance of the ruling is often exceedingly complex for CBP themselves where questions as to which processes or procedures are sufficient for a product to be “substantially transformed” must be answered, often based upon abstract descriptions. The global trade community have criticized CBP and other customs authorities on this very point, highlighting that determinations are subjective, inconsistent, and lack transparency.

When it comes to claims of origin and the resultant liability for duties that attach as a consequence, even would-be whistleblowers are unclear or entirely unaware as to whether there have been inaccurate declarations made to CBP.  This is ideal for fraudsters and the savings for unlawfully avoiding duties are huge—particularly under the Section 301 tariffs pursuant to the US-China Trade War.

What is clear is that where an importer is complacent, willfully ignorant, or simply negligent in their duty to exercise reasonable care, it can be easy to claim a country of origin that may not be in line with CBP’s view of the facts under the substantial transformation standard.  Would-be whistleblowers must be familiar enough the corporate supply chain to identify potentially problematic origin claims.  While this may have been a barrier to many trade-related qui tam cases to date, the impact to the bottom line of Section 301 duties are likely significant enough to be now visible to a broader spectrum of corporate employees including finance, tax, merchandising, sourcing, and distribution staff at US importers.  In short, the payment of Section 301 duties—or the avoidance of such duties—has likely made customs issues more top of mind at all levels of a company.

A. Mislabeling

This type of origin fraud is as straight forward as it sounds. This could take the form of declaring a different origin than the actual origin on the entry summary submitted to US CBP.  It may also take the form of applying fraudulent country of origin labelling on the physical merchandise and completing the entry summary in accordance with the fraudulent labelling.

Such mislabeling may result in unlawful avoidance of antidumping duties, US section 301 duties, the inappropriate claim of duty-free treatment, or simply an ability to import the merchandise at all where the goods may have otherwise been embargoed.

B. Transshipment

Under a transshipment scheme, merchandise is exported from its country of origin to a third country where it is unloaded from the carrier and loaded on board a new carrier for transportation to the United States. This unnecessary third-country transportation leg is used to support a claim that the transshipment country is the country of origin.  Notwithstanding the complexity of the rules of origin as described above—transshipment NEVER confers origin. It’s as simple to spot for inside whistleblowers as it would be for competitors who may also become whistleblowers of this type of fraud.

C. Structuring

This is most complex scheme to improperly alter the country of origin. Under such schemes, overseas manufacturers will move certain parts of the supply chain out of one country and into a third country in order to support a claim that the goods have been substantially transformed in the third country and are therefore properly identified as having originated in the third country.

Often, the parts of the supply chain that are relocated are immaterial or not value added segments such as packing, mere assembly of parts or sub-assemblies, testing and inspection, and so on.  The core principle here is that the steps moved from the country of origin to the third country are not sufficient to and would clearly not result in a substantial transformation.

Without a detailed analysis from a professional advisor or an opinion from US CBP (or both), such origin structuring may well be fraudulent.