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September 8, 2018

Import, Duties, and VAT Tax

by mikediliberto
With all the recent talk about tariffs and trade wars between the US, China, and others, it’s a good time to have an introduction to the process and costs that go along with global trade.
In episode 1 we will focus on sourcing goods in China and importing them into the United States, which by far makes up the majority of the questions that I get asked about Asian sourcing.
There are two major topics to cover, export and import.  In this case, we will be exporting our goods out of China and importing those goods into America.

Lets start at the beginning with Export

Export

All goods in China which are shipped out of the country are processed through export customs (There are exceptions for samples and small items). The most important reason for export customs processing is to ensure that suppliers receive their VAT refund.

This makes China fairly unique in the world; few countries process exports with such scrutiny; were I to export from the United States, by comparison, there would be no processing at all.

Furthering this complexity is the anti-counterfeiting regulations that have emerged in China in the past few years. Nowadays if you want to export any items which have branding on them, you must be an authorized exporter, a status conferred electronically by way of the nominated law firm representing the brand’s trademark in China. As manufacturers of branded product displays, these new regulations post a new hurdle to address with each of our brand customers.  In the past, a letter from a brand authorizing us to be an exporter of branded items was enough, nowadays the electronic filing is required.
One last note about being an authorized exporter.  For a variety of reasons, you may use a broker to process the export of your goods from China.  In these cases, it is the broker that must be authorized as an exporter, not you or your factory.

VAT Refunds

Many categories goods shipped out of China qualify for a refund of the VAT paid for those goods. Almost all transactions in China are subject to VAT, at various rates up to 16%. Once those goods are exported that VAT can be refunded to the exporter of the goods.  This is very important to know when dealing with factories, as their VAT refund can boost their profits, a savings which should be passed onto you if you negotiate well.

Export License

Going hand in hand with the ability to receive a VAT refund is to understand whether the factory that you’re working with has the ability to export on their own or whether they need to use an intermediary trading company. Two factors need to align in order to be able to have your factory accept US dollar payments and process their own export:

1. Business Scope – All businesses in China have what is know as “Business Scope”, which is simply the line(s) of business that company is authorized to undertake.  For example, if your factory has business scope for wood products but not metal, they could accept payments in US dollars and export wooden shelves, but they could not for metal shelves.

2. Export license – In order to export goods, a factory needs to have an export license.  Nowadays most factories that have an english-language listing on Alibaba or Global Sources have this type of license, but as you get deeper into your supply chain or meet suppliers in person in China, you might find factories that are only able to sell domestically.

Brokers

If your factory is not able to process an export from China on their own you (or, more likely, your factory) will need to engage the services of a broker. This has actually become so common that Alibaba has started their own export brokerage service. All brokers work in pretty much the same way. They accept your payments in US Dollars, they pay your suppliers in Chinese Renminbi, file all of the paperwork for the export of goods, and take a fee for the service. Typical fees these days are around one to two percent, but depending upon the line of business and the complexity of the export transactions some brokers will take up to three percent. Anything above three percent should send you running for the hills.

Brokers are different from trading companies in that, while trading companies often market the products made by the factories they work with, a Broker just rents you their export license in exchange for a service fee.

Invoices and Packing Lists

All shipments globally have at least two important documents attached, the Commercial Invoice (What is in the shipment and how much did you pay for it) and the Packing List (which items are in which boxes).

One of the most important pieces of information on the commercial documents is the Harmonized Code (also referred to as the HS Code).  The Harmonized Code is a standardized way of referring to goods, for the purpose of classification.  It is the classification of goods that dictates the tax or duty due on import, and the VAT refund due on export.

HS Codes

Despite the title Harmonized Code, these codes oftentimes differ between countries.  This means that the HS code your factory uses for export may not be the same code that you should use for import into your country. Having a good broker based in your home country is a great asset, however there is a lot of research which you can do on your own on the US International Trade Commission Website; start with the broadest category and then drill down.

When putting together your classification, consider the complete item being sent.  For example, you might be importing a display case, which consists of a frame of extruded aluminum, internal lighting, glass panels, and various plastic and steel trim pieces.  On their own, each of those parts are subject to their own classification and duty, but in this case, we would use a code representing the complete display case.

HS codes are comprised of a Heading and up to three sub-headings.  To classify the display case, we first choose the heading of 9403, which is “Other furniture and parts thereof”, then the first subheading is 20.00 “Other metal furniture” and the last is 50 “Other: Counters, lockers, racks, display cases, shelves, partitions and similar fixtures”

So, our total HS Code for these display cases is 9403.20.00.50 

Incoterms

Short for International Commercial Terms, the incoterms define the responsible party in the shipment of goods internationally. Of all of the corrections that I make in contracts, incoterms is one of the most common items in need of correction.

All shipments have the same basic stages; someone needs to be responsible to get goods to the port, export them, load them on a boat, sail across the ocean, import them into a country, et cetera. The incoterms tell us which party is responsible for each of these stages of the shipment, from EXW (ex-works) where the buyer is responsible for everything to DDP (delivered duty paid) where the seller takes care of all costs.

The incoterms change every ten years, and each time, we depreciate some terminologies; DDU and FOB are terms that are no longer in common use, for example.

You can find a chart of Incoterms here.

Fapio

The Fapio (or Fabio, as my iPhone keeps correcting) is the name of an official tax receipt issued to anyone that pays VAT. In order to get a VAT refund, you need to have Fapio for all of your VAT paid. This isn’t so much an issue for folks buying from China in US dollars, but helpful to know.  If for some reason your factory or trading company fails to receive the proper Fapio they lose the ability to get their VAT refund.

Import

So you’ve processed your goods out of China, gotten them onto a boat or plane, and now they’re imminently due to arrive in the USA. The earlier that you can get all of your paperwork in order, the smoother the import process with be.

Valuation

In your commercial invoice you’ll need to list a value for each item being imported.

The value of goods for import purposes is an area of constant discussion, yet there are clear standards that drive these valuations. Valuation methods are set by the World Trade Organization.

There are six standard ways to create a declared value for customs purposes, in descending order of preference:

Transaction value: The transaction value is the most basic, and normally the best method for establishing declared value. This is literally the value on the invoice, purchase agreement, contract, etc. This is by far the preferred method of valuation in our transactions.

Transaction values of identical goods: If the goods being imported are identical to a previous transaction, then that previous transaction can be used to value the import. This can also create issues for you if you are importing goods that have previously been imported by someone else.  Despite the fact that you may have received a killer deal from your factory, if another person imported the exact same goods from that same supplier, you may need to use that value for your import. Customs routinely reviews records of part numbers/descriptions/import prices, and will not be shy about coming after you for more duties and taxes if they feel that you’ve under-declared your values.

Transaction value of similar goods: As it sounds, this value is based on similar goods with similar specifications produced in the same country.  If you are brining in a steel shelving unit that measures four feet wide by eighteen inches deep by four feet high, you can claim a value based on similar goods imported before.

Deductive value: Starting from the sales price in the country of import, you deduct the value of each item of your margin.  Profit, transport, taxes, etc, all help your argument here to create a value based on removing costs from the sales price.

Computed value: The computed value or BOM-Cost method determines the customs value on the basis of the cost of production of the goods being valued, plus an amount for profit and general expenses.  Those buying finished goods from factories in China will potentially struggle to know their true BOM costs.

Fall-back method: Basically, if none of the other valuation methods above are possible, you can invoke the fall-back method, which allows valuations based on actual values of goods found in a variety of ways. This method is pretty rare in our world, and is best to generally be avoided.

Customs Bonds

In order to process an import, customs requires that a bond be posted. Bond values are normally a percentage of the import values of your goods.  There are two types of bonds that can be set up for your imports:

1. Single Entry Bond: This Bonds just how it sounds.  You pay a fee for your import which relates to that import only. Single entry Bond calculations vary, but are generally you pay $3-$4 per $1000 in value of your goods. The minimum charge for a single bond is $30-$40

2. Continuous Bond: A continuous bond covers imports for a rolling twelve-month period, and is valued at 10% of the value of imports during that period.  The minimum charge for a continuous bond is $450.  Generally, if you are processing a dozen or more imports in a given twelve-month period then you should have your customs broker underwrite a continuous bond for your company.

Power of Attorney

Since your customs broker needs to make the declarations to customs on your (or your company’s) behalf, you’ll need to sign a power of attorney (POA) form with whomever is processing your import.

Your customs broker will provide these forms to you in advance of processing the importation.

Summary

Customs can be complex but the more informed your are about the process smoother things will go. Hopefully this post has been informative, look forward to more in the future and leave feedback in the comments. Good luck!

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