Clients Can’t Compete With China?
Your clients can enjoy substantial import duty savings and U.S. Customs fee reductions by locating to a Free Trade Zone (FTZ). Here’s how.
February 14, 2008
by Chuck Swenson, CPA/PhD
While China’s labor costs are much lower than those in the U.S., we still have some significant benefits available for U.S-based companies. In an earlier column, I’ve written about special areas called Enterprise Zones (EZs), where qualified businesses pay little or no taxes. Free software is available if you’d like to see whether your clients qualify for EZ benefits.
Additionally, the federal government offers breaks for companies that are importing and exporting. If a company is located in a Free Trade Zone (FTZ), it is deemed outside of U.S. Customs territory. As a result, the company does not pay U.S. import duties when it first enters the FTZ; instead, duties are paid once it leaves the zone. The savings results in the time value of its money on payment of duties. If the good is actually re-exported directly from the FTZ (for example, the company does some further processing or assembly in the FTZ area), the company never pays any import duties.
No Duty to Pay Duties
The savings can vary. While duties are based on the type of product, the quantity, and where it is shipped from (under North American Free Trade Agreement (NAFTA), goods shipped between the U.S., Canada and Mexico are generally duty exempt), a reasonable rule-of-thumb is about five percent of the value of the import. So, if a company imports about $10 million worth of goods, and keeps the goods in its FTZ facility for two weeks before shipping to U.S. customers, at a 10-percent discount rate, the value of the deferment is $10 million *five percent*10 percent*(two weeks/52 weeks) or $1,923.
There is a special value to deferment for companies who add significant value to the product at the FTZ. If the value of its components is significantly different than the finished product, this can be a substantial savings, as shown in the following example.
Foreign Trade Zone Example
A chemical plant manufacturing hydroxywidgitpropolyne, which carries a 15 percent duty rate, uses the raw material oxyovertaxophene, which also carries a 15 percent duty rate, for one of its raw materials. Part of the production process consists of bringing the imported oxyovertaxophene to extreme temperatures. During this process, 30 percent of the oxyovertaxophene is lost as heat. If a processing company not in the Zones program imports $10M per year of oxyovertaxophene, it will pay $1.5M in duty as the raw material enters the U.S.
If the same company utilizes the zone program, it does not pay duty on the oxyovertaxophene until it leaves the zone and is imported into the U.S. Here, the Zone user brings the oxyovertaxophene into the zone with no duty owed. It then processes the oxyovertaxophene into hydroxywidgitpropolyne. During the process, 30 percent of the raw material is lost due to waste factors, so the $10M in oxyovertaxophene is now worth only $7M. Assuming all the end product is sold into the U.S, the 15 percent Custom Duty totals only $1.05M, or a saving of $450,000.
Geez, All the Fees!
There is also a $485 processing fee payable to Customs for each inbound (into the U.S.) shipment. However, companies in an FTZ can count all shipments in any one week as a single shipment for this fee. For example, suppose a company has 10 shipments per week, each worth $23,952. The “normal” (i.e., the firm is NOT in an FTZ) fees would be merchandise processing fee of $4,850 ($485 x 10) per week. If this number is annualized, the amount is $252,200 (52 x $4,850) per year. If instead the firm is in an FTZ, this could be filed as a single shipment of $2,309,520 each week. Here, the merchandise processing fee would amount to the maximum of $485 total for the week, or annualized utilizing Weekly Entry, $25,220 yearly. Thus, the FTZ saves $226,980 per year (or $252,200 minus $25,220), a savings of 90 percent per year.
Say Goodbye to My Little Friend
Wish you could lower your clients’ property tax bill? Goods in an FTZ are also exempt from state/local ad valorem taxes.
You Had Me at 90 Percent Savings — What’s My Next Step?
Your client needs to locate to an FTZ to take advantage of the benefits. There are over 300 general zones spread across the U.S. They are located in or near ports of entry, which are major water ports, but also include airports. Go to the Customs Web site to find out where they are and the paperwork necessary.
Your client may also want to explore the possibility of creating its own sub-zone. Hundreds of such sub-zones are scattered throughout the U.S. There is a lengthy process to get such status, since the client employs a contractor to act as if it were U.S Customs. Here, an FTZ specialist should be employed to help with the paperwork. A Google or other search engine search for “FTZ consultants” will provide a list of firms who specialize in this.
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Charles Swenson, CPA, MBT, PhD is Professor and Leventhal Research Fellow at the University of Southern California., and is Co-Founder of National Tax Credits Group. He has authored over 50 articles and two textbooks on taxation, and is editor of a treatise on state and local taxation forthcoming by Lexis-Nexis.