Friday, April 27, 2007

Foreign Trade Zones and NAFTA

This is a bit advanced, but it is interesting. There are probably people out there who have had the bright idea to double up on duty savings by producing NAFTA goods in a foreign trade zone. If you are doing that, be careful.

First, you need to understand FTZs a bit. For those who might not know, an FTZ is a specially designated area that is considered to be legally outside of the customs territory of the United States. FTZs are supposed to be reasonably close to ports of entry and are often divided into sub-zones for different users and purposes. FTZs are usually "granted" to a public or quasi-public entity like a Port Authority. The overall operation is then granted to some private entity. The agency in charge of all this is the Foreign Trade Zones Board though Customs and Border Protection does the heavy lifting on enforcement.

The beauty of a foreign trade zone is that importers can move goods into the zone and not make a customs entry until the goods are withdrawn for consumption. The importer has the option (assuming appropriate paper work has been done) of entering the merchandise either in its condition as admitted to the zone or its condition as withdrawn.

This has lots of benefits. First, if the duty rate on the foreign parts is higher than on the finished article (a so-called duty inversion), it makes sense to pay duty on the finished article. If there is no duty inversion, the importer can still benefit from the cash flow advantage of deciding when and how it wants to make the entry. Lastly, merchandise in a foreign trade zone is exempt from local property taxes.

An FTZ is not, however, a lawless no-man's-land. Being outside the customs territory does not make an FTZ a suitable location for your narcotics factory, unlicensed casino, or other illegal operation. The privilege only relates to the customs laws.

So, getting back to my original point, a clever strategy for a non-NAFTA producer might be to import all of the parts of some product into a zone and manufacturer the finished good there in a way that satisfies the NAFTA rule of origin. No duty on the parts going in and no duty on the NAFTA goods coming out. Perfect!

Except that the NAFTA negotiators figured that out. The NAFTA Implementation Act, at 19 USC 3332(a)(2)(A), says that the tariff-shift and regional value content means of qualifying your NAFTA goods does not apply to merchandise produced in a foreign trade zone if the goods are withdrawn from the zone for consumption. Customs figured it out too. In HQRL 961266 (Jun. 4, 1998)(sorry, I can't find a link) they applied this rule to sets of car seats and strollers. And, if you tried to export the goods from the zone to Canada or Mexico, the NAFTA drawback limitations kick in. So, in a technical sense, they got you coming and going.

Consider that a heads up for the next time you start brainstorming for duty savings ideas. Don't try this.


Nick said...

Larry, in the last paragraph you say "if you tried to export the goods from the zone to Canada or Mexico, the NAFTA drawback limitations kick in." Could an importer move the goods in-bond from the FTZ for immediate export to Canada or Mexico to avoid duty, or do the NAFTA rules "force" the importer to pay duty even though it would be duty free if it were shipping to anywhere else in the world?

Larry F. said...


I'm not sure I understand completely, so note the big disclaimer at the top of my page. I think your answer is: Yes, duty need to be paid once (although it might be spread out between the U.S. and the other NAFTA party). The reason being that the in-bond move still counts as withdrawal from the zone.

I think the relevant reg is:

Section 181.53(b)(4) which deals with foreign trade zones in the context of duty-deferral programs under the NAFTA:

For a good that is manufactured or otherwise changed in condition in a foreign trade zone (19 U.S.C. 81c(a)) and then withdrawn from the zone for exportation to Canada or Mexico or for entry into a Canadian or Mexican duty-deferral program, the duty assessed, as calculated under paragraph (b)(4)(i) or (b)(4)(ii) of this section, shall be paid no later than 60 calendar days after either the date of exportation of the good to Canada or Mexico or the date of entry of the good into a duty-deferral program of Canada or Mexico, except that, upon filing of a proper claim under paragraph (a)(3) of this section, the duty shall be waived or reduced in an amount that does not exceed the lesser of the total amount of duty payable on the good under this section or the total amount of customs duties paid to Canada or Mexico.

Nick said...

My question wasn't completely clear--I had a hard time phrasing it without using a concrete example. Plus I failed to use the phrase "temporary admission" which is what I was specifically referring to. Plus I think I was confusing issues. But you managed to answer it anyway. I had not seen that particular statute, but the last paragraph makes it clear that, in a "temporary admission" situation, waiver of duty is proper regardless of NAFTA rules. I was thinking specifically of jet fuel that gets entered into an FTZ in the US, then is moved out of the FTZ under bond to an airport and onto a commercial jet, which then flies to oh, let's say Venezuela. Waiver of duty is proper in this case under "temporary admission" rules. What if it flies to Toronto? Without reading paragraph (a)(3), it looks like duty deferral is still proper according to the reg you referenced.

canadian said...

Interesting post Larry.
As you may know, Canada has started to develop its very first FTZs, and I was wondering whether you had any idea what labour regulations would govern them? Would workplace health and safety be monitored federally or provincially?

Paul said...

Interesting. But what happens if the product is not produced in the FTZ, but only manufactured. For example, I produce a good in USA and send it to Panama to make the packaging there. What would happen then? Is the NAFTA agreement still valid?