While it’s been around for several decades, the first sale rule appears to be generating renewed interest as an option to potentially lessen the impact of tariffs on Chinese goods imported into the U.S.
“We’ve seen a real increase in nontraditional first sale clients, clients who are importing things that aren’t traditionally subject to higher duty rates,” said Mark Segrist, an import and export trade lawyer and Chicago-based member of Sandler, Travis & Rosenberg. The firm established the first sale rule 30 years ago through litigation.
Segrist added that more importers are “coming to us and asking about the opportunity to use first sale where maybe six months to a year ago this wouldn’t have been on the table for them.” Those importers are in an array of industries, from agricultural products to home appliances and bathroom accessories, that are now feeling financial pressures from U.S tariff hikes on Chinese goods.
When leveraged properly, the rule can help certain businesses reduce custom duties on imports, according to international trade lawyers. But they caution that the rule isn’t a loophole for avoiding tariffs under the Office of the U.S. Trade Representative’s Section 301.
“The first thing to know is that it’s not an exemption or exclusion from 301 duties,” said Washington, D.C.-based Hogan Lovells partner and international trade lawyer Craig Lewis. “It’s just identifying a basis for lowering your customs value.”
Lewis and other international trade lawyers at his firm were fielding calls earlier this week from clients who wanted to know more about the first sale rule after reading a report from the South China Morning Post. The publication reported that Deloitte and PwC representatives had given a presentation to a group of business leaders in Hong Kong about using the rule to “avoid paying tariffs in China, but mainly in the U.S.”
Representatives from Deloitte and PwC, also known as PricewaterhouseCoopers, did not respond to emails seeking to confirm the meeting.
Here’s how the rule can work: A manufacturer in China sells a $25 item for $50 to a middleman in Hong Kong, who then sells the item to an importer in the U.S. for $100. The default position of U.S. Customs and Border Protection would be to impose a duty fee on the $100 sales price, said Lewis. But he said under the first sale rule, the duty fee would be applied to the $50 price that the manufacturer charged the middleman.
“The 301 duties are ad valorem duties [a percentage of the customs value], so if you’re importing at $100 a unit and the first sale can reduce that to $50 you’re saving 50 percent of the duties,” Lewis said. “It’s an interesting option.”
Companies that are considering using the rule should first look at how much they’re paying in import duties, either from their overseas factory or a middleman. And if there’s no middleman, the company could take steps to establish one, Segrist said.
“We’ve worked with companies in the past to work with their factories to set up strategic middlemen companies that are sometimes related to the factory and you can then shift qualifying expenses over to the middlemen companies and create some savings,” he said.
But making the rule work isn’t simple. The transaction between the manufacturer and middleman must be a bona fide sale, complete with a transfer of title. The middleman cannot act as an agent, only as a purchaser. And while the two parties can be related, the scenario could make it more difficult to prove that the transaction was a bona fide arm’s-length sale and that the price was fair, according to Lewis and Segrist.
Lewis added the item in question must be destined for exportation to the U.S., which means the middleman can’t place it in a general inventory that gets sent out all over the world.
And there’s another hitch: Customs and Border Protection views the first sale rule with a wary eye. Sandler, Travis & Rosenberg published an alert this week warning clients that the agency was “scrutinizing imports using this valuation methodology more closely as part of a broader increase in enforcement efforts.”
The firm also noted the agency has “always had an uneasy relationship with the first sale rule and has attempted several times to eliminate it or make it more difficult to use. With these efforts having been unsuccessful, CBP has instead frequently turned its attention to ratcheting up efforts to verify that companies using this methodology are doing so properly.”