Substantial Transformation Key to Avoiding Section 301 Tariffs, but Achieving It Can Be Tricky, Lawyer Says

Increased CBP scrutiny on valuation, changes in tariff classification, and country of origin for products targeted in the U.S.-China trade war means companies need to be extra careful when doing tariff engineering or shifts in assembly locations, Sandler Travis lawyer Paula Connelly said, speaking on an April 28 webinar offered by the Coalition of New England Companies for Trade. Most of her presentation focused on establishing country of origin.

“One of the things I want to stress is: country of export and country of origin aren’t always the same,” Connelly said. She walked attendees through examples of goods that had more processing done in the country that received components, but the country where the original components were made was considered the country of origin.

For instance, a South Korean company made and printed paper, and cut it. Then, in China, the paper was laminated, glued into the shape of a bag. The cardboard to allow the bag to stand up was added, holes were punched and grommets were placed over them, and handles were added. The gift bag was South Korean, CBP said.

Connelly said that if you're moving assembly of a good subject to Section 301 tariffs, but keeping all the component production in China, “Customs will likely take the position you had a simple assembly.” And simple assembly does not change the origin, according to how CBP evaluates substantial transformation. They look at the level of degree of skill and technology required, she said.

Connelly said substantial transformation is not a black-and-white rule, unlike tariff shift rules that are used in NAFTA, where if the first four digits of the Harmonized Tariff Schedule number are changed in Mexico, it doesn't matter if the input was from China, it counts as a Mexican export.

“You should not be leaving that determination to your supplier in China,” she said -- and if possible, you should travel to the new country to inspect the assembly operations yourself. Not only is there the issue that the assembly may not qualify as substantial transformation, it's also possible that the China supplier is just shipping a completed product to Malaysia, and telling you assembly is occurring there.

“Transshipment [of Chinese goods] has and will continue to be a higher priority area for Customs,” she said.

Connelly said she's worked with some clients to flip the supply chain. Instead of trying to avoid Section 301 tariffs by sending Chinese components to another country in Asia, some clients are sourcing components from other countries and having final assembly done in China.

If CBP disagrees with your country of origin, as long as you took reasonable care, there won't be penalties, she noted. CBP has a publication with reasonable care checklists she recommended consulting.

Because the costs of getting it wrong are so high with 25% tariffs, Connelly said many companies are asking for a customs ruling on substantial transformation of their products. She said, “What you don’t want to do is just send it into Customs and say: ‘What’s the country of origin?’” Rather, you should have an argument of why there is substantial transformation, and send that reasoning in the hopes CBP attorneys agree with your decision.