Impact of COVID-19 Reflected in China Tariff Exclusions and Year-End Transfer Pricing Adjustments

The U.S. Trade Representative (USTR) announced on December 29, 2020 that approved exclusions from U.S. Section 301 tariff measures for certain Chinese medical care products used to deal with COVID-19 are being extended and added more medical products to the list of exclusions. The extensions are granted based on “medical necessity” to help with COVID-19 readiness capabilities in the U.S. The exclusion extensions and modifications (covering 68 unique product descriptions and 31 10-digit HTSUS codes) are effective for three months commencing on January 1, 2021 and ending on March 31, 2021. All other approved exclusions for Chinese goods expired on December 31, 2020, thus U.S. businesses are required to deposit additional duties of either 25% or 7.5% on covered merchandise imported in 2021.
 
Multinational corporations (MNCs) engaging in cross-border tangible good transactions should consider these additional Section 301 tariffs as part of their typical year-end transfer pricing adjustments for income tax purposes, which form part of the MNC’s “total tax liability.” Mitigation strategies should include seeking duty refunds from U.S. Customs & Border Protection (CBP) to offset additional income tax that may be owed to optimize tax outcomes.

 

Background

Since 2018, the U.S. has imposed additional tariffs of up to 25% on Chinese products with an estimated trade value of $550 billion under Section 301 of the Tariff Act of 1930. The tariffs were imposed in response to the U.S. investigation of China’s “unfair acts, policies, and practices” related to technology transfer, intellectual property and innovation. However, the U.S. has also established a process to enable U.S. stakeholders to request exclusions of particular products and, thereafter, an extension of the duration of certain approved product exclusions that expired.
 
The tariffs merit careful thought in the context of their consequence to total compensation, particularly on margins realized in the U.S. MNCs with Chinese operations employing a classic supply chain model involving contract manufacturing operations or limited risk distributors have unique considerations. The combined effects of the coronavirus pandemic on Chinese production and suppressed global demand could severely impact the overall profitability of MNCs, which may now need to review the supply chain models for their Chinese business segments.
 
The cost-plus and fixed profit margin compensation models traditionally employed may no longer be considered reasonable and sustainable, since the arrangement may overburden the principal/entrepreneur. In the current economic environment, these structures should be reviewed to determine how declines in profit (i.e., losses) should be shared among the manufacturer, U.S. or foreign principal, and U.S. distributor, as applicable.

Customs Valuation Planning Options

Businesses may wish to review the following areas to better understand the interdependencies of international tax and CBP valuation rules to achieve positive outcomes:

• Evaluate the impact of expired, extended and new product Section 301 exclusions on U.S. merchandise imports;
• Evaluate whether product exclusions were correctly applied on past U.S. import declarations and secure refunds, where applicable; and
• Use a multidisciplinary approach to assess current transfer pricing models to counterbalance total tax liability, especially with respect to customs duties and indirect taxes.

 

How BDO can help

Customs duties and trade policy present unique challenges that businesses face when conducting regulated cross-border transactions. BDO’s Customs and International Trade Services practice can help businesses navigate the complex rules governing cross-border product movements to minimize duty and tax payments and maximize import and export compliance.
 
Our services include: 

• Support transfer pricing analysis to balance income tax and duty outcomes to achieve the lowest possible customs value
• Evaluate cost unbundling options to legally lower the customs value declared
• Evaluate whether sourcing changes meet “substantial transformation “tests for determining country of origin
• Support strategic planning efforts to manage the impacts of tariffs
• Qualify goods for duty relief or duty-free entry
• Identify and reclaim available duty refunds