The current trade spat between the US and China has alarmed many global businesses. Higher tariffs mean higher import taxes on goods manufactured in China and shipped to the US for distribution. Unfortunately these tariffs are likely going to be long-lived in nature, and businesses will feel the effects the most.
There are multiple ways that businesses can address these tariff changes, so that they don’t incur additional costs if they are importing goods from China and distributing them to countries outside the US. Below are three main ways that a business can adjust.
In the past, exports from the US haven’t caused many financial implications because import duties into the US were minimal. However, considering the potential 25% tariff increase, exporting goods to international countries from the US becomes prohibitive. For example, a US-based company with products manufactured in China, who imports into the US, will have to pay the 25% import tariff to get their products into the US; if they have any retailers in Canada or the EU they will then have to pay additional export duties to those destinations.
To mitigate this high tariff scenario, there is a solution called duty drawback, a refund in payments that are initially collected upon importation of foreign-made goods. US customs issues these refunds only when the imported merchandise is exported out of the country. With a 25% import tariff, it becomes worthwhile to reclaim the import duties paid through duty drawback. For example, if a company imports 100 items into the US and pays 25% import duty and then exports 40 of these to Canada, then the import duty paid on 40 items can be recovered with duty drawback.
To qualify for duty drawback, products must be one of three types:
- Manufactured—goods that are used in the manufacture of finished goods to be exported
- Rejected—defective goods, items that don’t meet specifications at the time of importation, or items that are shipped without consent. (These items must be shipped to US Customs within three years of importation).
- Unused—items that are not used or have not entered the commerce of the US
If goods are destroyed before being distributed, they are also eligible for duty drawback, but the destroyed parts must have no commercial value and the process requires supervision and verification by US Customs.
Non-resident importer (NRI)
Instead of importing products into the US and then redirecting them to other countries for distribution, a company can elect a foreign or non-resident entity in the final-destination country, to directly import products made in China. With high tariffs it makes more sense to import products directly, whether it’s to EU, Australia, or Canada—all of whom allow the concept of foreign or non-resident importer.
How NRI works:
First, a company needs to legally set up as non-resident importer in the country that will receive the goods from China (Canada, or Australia, or any of the EU countries), and get a tax number. As an established non-resident importer, the company can import the product into the country, use a local warehouse to store the product, and pay a special import tax called “goods and services tax” (GST) in Canada/Australia, and “value-added tax” (VAT) in the EU (the mechanism for GST and VAT is essentially the same). GST/VAT is a “pass through” tax to the end consumer so the net tax liability to the company is zero. All the import GST/VAT paid is refunded to the company at the end of the tax filing period.
This is currently the preferred method for American businesses wanting to distribute their products in Canada, Australia, and/or Europe. The benefit being that a company does not have to set up a local tax entity, and does not have to pay any income or state taxes in the destination country because of its status as a foreign or non-resident importer (any charges will be reimbursed at the end of the filing period). There is a cost to get set up as a non-resident importer, although it is a fraction of the cost incurred by setting up a local tax entity—plus there is less paperwork and compliance issues to worry over.
In the EU, the two popular destinations are the UK and the Netherlands. Because of Brexit, Netherlands seems to be the top destination for companies wanting to ship to the rest of Europe. In this scenario, the company can send products directly from China to the Netherlands, pay the import VAT, and stores the product in a Dutch warehouse. From that Dutch warehouse, products can be sold to consumers in the 27 EU countries. The VAT will be charged to the end customers who live in those 27 EU countries. And the quarterly VAT return filed helps recoup the import VAT paid. In the Netherlands, the import VAT can also be deferred.
Shift high-tariff product out of China
In order to get out from under the tariffs all together, many companies are moving their manufacturing and supply chain out of China into nearby countries such as Vietnam, Malaysia, and Taiwan. Even Mexico is being considered (although there are potential new tariffs there). While this does cause a disruption to production, it can hopefully be short-term, and pay off with a viable long-term strategy to counter the unpredictability around tariffs. This trade war is an ever changing political situation and it seems that this particular tariff war will last for quite some time.
As of June 2019, many trade tariffs are in flux and are under threat of rising. Tariffs can change quickly, and aren’t specific to the US trade relationship with China. It is wise for small companies and startups to seek out experts in international trade and logistics who can help them stay up to date on new regulations and laws.