US importers of goods from China awoke Friday to the news they had long dreaded: that President Donald Trump was not bluffing on escalating tariffs on Chinese-made goods, as the rate on $200 billion worth of imports increased from 10 percent to 25 percent.
What’s more, another $325 billion in goods from China could be at risk of higher tariffs if Trump’s tweets are any indication. The question for shippers now is whether they have any recourse within their control to impact tariff rates on their goods.
The options are limited. Importers can attempt to move their production or final assembly to other countries, but that’s a difficult — sometimes impossible — path. They can hold back on purchase orders in the hope that the newly implemented tariffs are rescinded after further trade negotiations with China. There are also tariff remedy programs that often go underutilized by importers, including the Section 301 exclusion process, by which shippers can apply to have their goods continue to enter the country duty-free under certain circumstances.
Carriers and non-vessel-operating common carriers, meanwhile, indicate it is too soon to see any changes in shipping patterns, either in terms of shipments being booked in China or in movement in freight rates on the spot market. Kevin Krause, vice president of ocean services at SEKO Logistics, said that if there is going to be an impact, it will be reflected in bookings for sailings 14 days from now.
That doesn’t mean that importers are taking the matter lightly. Clients are already asking for quotes on shipments from base ports in Taiwan, Vietnam, Indonesia, and Malaysia, where some of the products they import from mainland China may also be produced, he said.
The real movements in spot rates will occur later this year, when vessel operators begin to take ships out of service for a week or so as they transition to the use of low-sulfur fuel, said Lawrence Burns, senior vice president of trades and sales at Hyundai America Shipping Agency, part of HMM. Customers do not expect to make significant changes in their purchase orders leading up to the peak season due to the tariffs, he said.
“The demand side won’t change a whole lot due to the tariffs. The more significant changes will be on the supply side,” Burns said. The removal of vessels to transition to low-sulfur fuel will begin in the third quarter and continue through the fourth quarter, he said.
Engineering a change in product makeup
Another route is attempting to change the makeup or assembly process of a product to minimize exposure to tariffs. This process, called “tariff engineering,” has long been a feature of global supply chains where existing tariffs compelled an import manufacturer to stage different parts of a product’s assembly in different regions to avail itself of lower-duty treatments in each locale.
For instance, a customs brokerage representative told JOC.com that under the Harmonized Tariff Schedule (HTS), pants are defined as a garment with two closed legs, so apparel makers will sometimes produce the pants in one country without sewing the inseam, then ship it to another country to sew the inseam, thus transforming the product from one HTS code to another. A single pair of pants might touch two or three countries simply due to tariff treatment on various components of the pants, or stages of the manufacturing process. Pants are not subject to the 301 China tariffs, but have long been subject to other tariffs, some as high as 30 percent, hence the well-established strategy of reducing tariffs by shifting some aspects of production to another country.
“There are many legal ways to engineer a product so the tariff classification can change,” Amy Magnus, director of customs affairs and compliance with the customs broker AN Deringer and the president of the National Custom Brokers & Forwarders Association of America (NCBFAA) told JOC.com. “There will always be tariff engineering.”
For example, Magnus said a maker of toolkits might find that one tool in the kit is subject to 25 percent duties under the Section 301 tariffs on Chinese-made goods. The entire kit, then, might be classified on the most expensive item.
“You take the dutiable tool out and it changes the classification. You’re adding something or taking something away, or changing it in some significant way from a tariff point of view, but not from an end-product point of view.”
Magnus said the current trade environment has had the positive effect of forcing importers to look more closely at their product classifications, as well as the structures of their supply chains.
“This might be forcing them to look at their classification and that’s a good thing, though they may also have to deal with the fact that they’ve been classified wrong for many years,” she said. “If they can’t move the production, there are sometimes opportunities to change the classification by changing the product itself. Freight can be deducted if you know the actual freight and it was included in the price of the product. At a 3 percent rate, it wasn’t worth it to separate that out. But at 25 percent, it might be.”
Magnus added that there’s also been an uptick in drawback requests, because 301 duties are eligible for drawback. Drawback is a refund on duties paid on products imported into the United States that are exported within a certain period. Again, she said, while many companies eschewed the drawback opportunity at a lower duty rate due to the administrative burdens of the program, at the 25 percent tariff level, the math changes.
“We’ve definitely upped the dialogue with our clients,” she said. “Where there might have been opportunities not investigated in the past, because these tariffs involve so much money, companies are leaving no stone unturned.”
Tariff engineering is not achievable overnight, however, as it revolves around the orchestration of different suppliers in different countries, as well as freight transportation between the countries, which could end up offsetting any tariff savings.
Reclassifying products comes with risks
A corollary to tariff engineering is reclassifying products to evade tariffs, but that may not produce the desired result. Changing a product classification to escape an existing tariff is risky because the new classification could be hit with a tariff as the process is worked out in Washington, said Susan Ross, a Los Angeles customs attorney. The challenge for importers is to determine what action they can take in the short term that will be effective, but the reality is that little can be done.
“If you didn’t do something by now, you’re already in trouble,” Ross said.
Reclassifying a product can also raise a red flag with US Customs and Border Protection (CBP), since that agency would be curious as to why a product was abruptly reclassified. Alternatively, CBP might wonder why the product was wrongly classified in the first place.
Many importers have sought tariff exclusions under the Section 301 tariffs on Chinese-made goods, but Ross said that is laborious and takes months. The US-China tariff war has been under way for almost a year, and the Office of the US Trade Representative (USTR) is still processing exclusion requests filed last July, she said.
The specter of 25 percent tariffs on imports of Chinese-made goods is turning a minor margin squeeze into a game changer. When the tariff was 10 percent, the Chinese manufacturer and US importer often split the added cost. “Each side took a hit. At 25 percent, they can’t do that,” she said.
Importers who are considering canceling purchase orders until there is more clarity as to how the trade war develops may face extra costs and other issues on both sides of the transaction. Most contracts with retailers have a penalty clause for not fulfilling the terms of the agreement. Also, a sudden cancelation causes ill will with suppliers in China, which can affect future transactions, Ross said.
Importers could also petition USTR to have their products excluded from the tariffs, but that office is so backed up with petitions from the first three lists of tariffs last year that they have not completed the requests that were filed last summer and they are just now getting to the list that was published in December, said Matt Priest, president of the Footwear Distributors and Retailers of America. “We’ve told our members don’t rely on the exclusion process to bail us out,” Priest said.
Pete Mento, vice president at Crane World Logistics, noted in a LinkedIn thread Monday that some of the tariffs will fall to Chinese exporters to pay, and some of those suppliers will find the tariffs untenable. He said it’s wrong to assume that US importers will bear all of the brunt of tariff costs, although US consumers will likely shoulder the burden of higher retail costs no matter which company pays the tariffs.
“A significant amount of US imports from China are sent under the [Incoterm] DDP [delivered duty paid], which requires the exporter to pay for [among other things] the duty,” he said. “It is important to note that many Chinese firms are, in fact, paying these duties. Having spent time speaking with my counterparts at other customs brokers, we all agree many of our transactions actually fit this DDP model.
“Who knows how it all gets sorted out, but one way or the other, it isn't just the US consumer that suffers,” Mento added. “If you suddenly have to account for a rise of 25 percent in the cost of your goods to your largest market that nobody else is paying for, you're sunk.”
Salvatore Stile, president at the freight forwarder Alba Wheels Up, asked in the thread “What financial lenders are willing to increase credit facilities by millions of dollars to importers and take on additional exposure?” To which Mento replied, “Nobody is talking about this. Or the increase to bonds we are all dealing with.”