Thursday, February 22, 2007

Is NAFTA Drawback Constitutional?

The Court of International Trade took up this question recently in Nufarm America's Inc. v. United States, Slip Op. 07-23 (Feb. 15, 2007). Rather than create false suspense, I'll just tell you that the Court held it is constitutional. Let's take a look at the case.

You need to understand the crazy world of duty deferral under NAFTA. When negotiating NAFTA, the parties identified a potential problem. Assume a manufacturer in the U.S. imports non-NAFTA parts but they are duty free because the manufacturer is a is in a foreign trade zone, uses a temporary importation bond, or subsequently claims drawback. Absent the FTZ, the parts would have been subject to a duty of, say, $100. If, the parts are used to produce a NAFTA-originating product, the finished good will likely be duty-free on export to Mexico or Canada. That means that because of the FTZ, the non-NAFTA parts escape duty when entering Mexico or Canada. That sets up a scenario where a NAFTA party (read that as "Mexico") could become an "export platform" for non-NAFTA goods and that was not the intent of NAFTA.

To avoid this perceived problem, the parties decided that someone should get paid that $100 at least once. To accomplish that, the NAFTA requires--in Article 303--that the parties limit the waiver or deferral of duties to the lesser amount (amount, NOT rate) owed to either the country where the goods were first imported or the NAFTA party to which they are subsequently exported. In the example above, the lesser amount owed is the zero due on the finished NAFTA-originating goods exported to the Mexico or Canada (as compared to the $100 owed to the U.S. but for the FTZ). So, the U.S. is permitted to waive or defer only zero, meaning that the importer into Mexico has to pay $100 to the U.S. when the goods are exported.

If the duty going into Mexico were $25, the U.S. could defer that amount meaning the U.S. would collect $75 ($100 - $25) and Mexico would collect $25. The total is the $100 normally due the U.S.

That's enough detail for now. There are exceptions for certain transactions. Also, I do know that drawback only refunds 99% of the duties paid. If you want the details, look at 19 C.F.R. sec. 181, Subpart E.

NuFarm was apparently paying attention to the harbor maintenance tax litigation and remembered that Article I, Sec. 9 of the Constitution says: "No Tax or Duty shall be laid on Articles exported from any State." Given that the NAFTA rules require the payment of duty 60 days after exportation, it seems natural to ask whether that requirement is constitutional.

The government argued essentially that the duty does not arise as a result of the exportation. Rather, the duty liability is the result of importation of dutiable merchandise. Thus, the argument goes, the export clause is not invoked. This makes some sense. What is being paid is an import duty. Also, as the Court points out, there is a rational reason for the restriction of duty deferral benefits. Thus, the Court finds for the U.S. and dismissed the case.

At first I was on board with this. The duty involved is a normal import duty. The liability results from importation.

But, now I am wondering. Assume for a minute that NAFTA was not involved. The merchandise comes in on a TIB and is subsequently exported. No duties are owed. That means that in a TIB situation like Nufarm's, importation does not result in a duty liability. Neither would exportation. But the NAFTA drawback rules change the result. The goods come in free of duty just like any TIB. Duty liability only attaches when exported and only when exported to Canada or Mexico. It seems reasonable to conclude that the NAFTA drawback rule creates duty liability that would not otherwise exist and that it is triggered by the exporter's choice to ship to Canada or Mexico as opposed to any other destination.

The CIT's analysis is thorough and a perfectly reasonable. But, it seems as if there is room for reasonable minds to disagree on this point. That, my friends, is why they created the Federal Circuit.


Anonymous said...

Thanks for the website. I appreciate your efforts in providing comments.

I have some comments. First, the case is not about NAFTA drawback. It is about NAFTA duty deferral limitations. When a good is brought into the US and goes through a duty deferral program (FTZ, bonded warehouse, etc.), in some cases the exporter is required to file a customs entry after exportation (if exported to MX or CA). This requirement only kicks in if the item being exported to Canada or Mexico is not in the same condition when exported. Therefore, it really is meant to capture situations where you bring goods into the US and do some type of manufacturing process. It does not apply to the simple distribution warehouse situation.

NAFTA drawback is similar, but not the same. NAFTA drawback involves an import into the United States, the export of a good to Canada and Mexico not in the same condition as imported, and then a claim under US law for drawback refunds. As you point out, you are only entitled to drawback of 99% of the duty paid. Because NAFTA drawback is similar in concept to the duty deferral program, the NAFTA agreement limits the 99% drawback refund to a similar lesser of 2 countries duties calculation. Today, almost all goods manufactured in the US that qualify for NAFTA are duty free, making the lesser of the two duties zero. In simple terms, if you qualify for NAFTA, you are not going to get any drawback on components included in the article manufactured in the US.

I point this out because the case was really based upon the unconstitutionality of taxing an export by requiring the NAFTA duty deferral entry. If NAFTA drawback was involved, it would only be the constitutionality of a refund on previously paid duties. I understood the issue to be whether the US could tax an export by requiring the submission of a duty deferral entry.

Also, the things you can do to a good under a TIB are fairly limited so it is likely that the good being imported will be in the same condition when exported. When that is the case, NAFTA duty deferral does not apply.

Larry F. said...

I love getting comments. And, despite that, I hate comments like the one above. It makes me write like a lawyer and I hate that. Lawyers universally think they are good writers. Most are not.

Obviously, Anonymous knows this area well and is right on all points raised. Except that it doesn't make me wrong, it just makes me have to explain it a bit more like a lawyer.

Here's the thing. I know the difference between a TIB and duty drawback. I suspect the vast majority of readers who stop by this site for more than a moment do too. Nufarm was about a TIB.

The post is clear--I think--that I am trying to get from Nufarm to the bigger issues. I was not focusing exclusively on drawback, TIBs, FTZs, or any other duty deferral or waiver mechanism but on all of them.

In my experience, these restrictions are collectively referred to as NAFTA drawback, which is--I admit--inaccurate and possibly confusing. Part of the reason for this is that the regulations, at 19 CFR 181.1(o), state: "NAFTA drawback. NAFTA drawback means any drawback, waiver or reduction of U.S. customs duty provided for in subpart E of this part." That includes TIBs. Also, 19 CFR 181.41, the section explaining the scope of the NAFTA drawback and duty deferral procedures clearly states that "the requirements and procedures set forth in this subpart for NAFTA duty-deferral programs are in addition to the requirements and procedures for . . . temporary importations under bond contained in part 10 of this chapter."

So, I think I am justified in my original post. I also think everyone but a lawyer understood exactly what I was getting to. But, I appreciate the comment in the sense that it keeps me honest and contributes to the overall clarity of the site.

Anonymous said...

I wasn't trying to do a "gotcha" and I think you took this in the wrong way. It really was an honest comment on an issue that I believe is confusing for many and needed clarity. In fact, this was brought to my attention by a non-lawyer that was concerned. I think you should be flattered that your blog is widely read and I, for one, appreciate you doing this. First, I just don't think the average person involved in this field, be it broker, lawyer, accountant, import manager, etc. understands NAFTA drawback and NAFTA duty deferral as the same thing. That is certaily not the case in the drawback field. What caught my eye about your post (and why it was sent to me) is the catch line about NAFTA drawback being constitutional. Those in the field that are not lawyers immediately sat up and took notice about implications for drawback. Drawback involves important refunds for large corporations and connecting the words drawback and constitutional can send a chill up any corporation's spine. So, my point is that those that are not lawyers understand drawback and duty deferral to be two completely separate things. I just wanted those reading to be clear that Nufarm has no implications for NAFTA duty drawback. Second, you are correct that the regulations in some instances confuse the concepts of the duty deferral and drawback. Part 181 regulations are, perhaps, some of the worst ever drafted. That probably flows from the fact that they are trying to put into practice some very convoluted deferral and drawback procedures. I am sure that the original drafters of these NAFTA provisions regret what they have done. Still, there is a clear difference between NAFTA drawback and the entire duty deferral scheme that had to be created after NAFTA. Finally, I think an important distinction exists in Nufarm between what that court was addressing (the constitutionality of the NAFTA duty deferral limitations) and NAFTA duty drawback. NAFTA duty deferral requires the filing of a Customs entry by virtue of an export. It was this quite unusual and recent NAFTA invention that was at issue in the case. Can you tax an export by requiring the filing of a Customs entry? That same issue is not present for a drawback- simply a refund of previously paid duties.

Larry F. said...

Oh, I truly dod not mean to sound offended. I was just expressing my own frustration at not having been as clear as possible. As I said, you are right and I did not take your comments as an effort to make me look bad. Really, I appreciate the comment and the fact that having smart readers keeps me honest. Thanks again.

Anonymous said...

Regardless of the issues and shortcomings pointed out so eloquently by you, what is the main reason if one exists that makes it difficult to actually file and claim their entitled draw backs. In B School I remember a paper from 2001 that suggested that over $1 billion dollars annually goes unclaimed.

Quisnos Constitution said...

so i as a layman can consider that Nafta is in place to Allow free access for mexicans coming into the us and into canada. and to the tune of over 30 million, so as to sequester jobs that are being moved by Gatt to china and urasia,etc and that i must suppose that the american people mexican ,canadian are being bilked out of the jobs necesary to maintain a incorporated country, and the truth not being told is that the mega corporations manufacture laws to pull all worth from these countries so as to build their new world order................................ Hmmmm I would say that it is time to break out the hardware and teach our neighbors from the north and south how our founders protected our lives and liberties at the expense of other former tyrannts. ...............For in this

corporate government today is being controlled by Goldman sachs and morgan stanley who through illegal activities have purchased these 3 countries................ Well sir God is my leader and many more of us who are in this ship. we trust none in the executive, house of representitives, senate and the judicial system. So i put to you that these institutions must come back into the line of the original agreements and contracts designed for the soveriegn entities ( people of their Republics). For we did not vote on Gatt or Nafta our representitives did. And this Constitution was made as a contract between the states and the federal Government. And i sir have one contract like do all the people. the declaration of independence. much missaligned, but read it and it will tell all that when the people feel the despotic chains of any tyranny to a point of no return........ From God we recieve the ability to step in and change this despotic beast. for Common law is simple and the grey patches placed into it by the Government Now in power will be overhauled. . And i can attest to that fact by the very laws of GOD. Quisno,