Trouble at the border – The top 10 customs-related issues facing Canadian importers

(As originally published in the Financial Post, July 2012)

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By Sylvain Golsse and Mary Anne McMahon, International Trade and Customs - Indirect Tax, Ernst & Young LLP

In today’s global economy, the transportation of goods could have significant customs implications. Moreover, customs duties can have a direct impact on the bottom line. Unfortunately importers often overlook or mismanage duties and customs compliance, which can result in significant and unnecessary duty costs.

Below, we’ve outlined the top 10 customs-related issues facing Canadian importers.

1. Origin preferences: Although imported goods can be subject to customs duties, preferential origin treatments such as the North American Free Trade Agreement (NAFTA) can provide significant duty relief to importers.

Canada has numerous multilateral, bilateral and unilateral origin-based relief mechanisms in place. Importers should be aware of and take advantage of any applicable origin-based duty relief opportunities. Otherwise, they can face significant unnecessary duty outlays that have a clear impact on the bottom line.

Importers that do take advantage of origin-based duty relief opportunities need to ensure that they manage them appropriately. This includes having valid and complete documentation and the respective rules of origin need to be followed. Failure to properly apply and document preferential origin-based duty treatments could result in significant duty costs, and in some cases, duty relief could be revoked.

Importers can leave significant duties on the table and be subject to significant compliance-related costs if they do not manage matters appropriately.

2. Duty drawbacks: Duties can be refunded under what is known as a “duty drawback.” While often overlooked, there is the possibility to recover duties on imported goods that are subsequently exported. For example, if a Canadian-based enterprise expands into the US, whether through the establishment of locations in the US or through e-commerce, its goods — some of which were initially imported into Canada — will likely move to the US.

Importers need to keep an eye on duty recovery opportunities when goods move between countries. Whether the movements are a result of returns, sales or inventory transfers, the opportunity to recover previously paid import duties needs to be taken into consideration.

3. Bonded warehousing: Instead of immediately paying duties when goods are imported, the use of a bonded warehouse may provide an importer with the opportunity to defer the payment of applicable duties and import taxes, such as the goods and services tax (GST), until the goods are removed from the bonded facility and sold in Canada.

A bonded warehouse can also be used to eliminate the need to pay and then recover duties via duty drawbacks when the goods in question are destined for export.

4. Related-party purchases of goods and services: Importers purchasing goods and services from a related party need to consider potential customs valuation ramifications. What may be acceptable as a transfer price for income tax purposes may be unacceptable for customs valuation purposes.

Although some transfer pricing and customs valuation methodologies may resemble one another, it is crucial that an importer buying from a related party ensures compliance on both fronts. Failure to do so could place the importer in a possible exposure position for duty and penalties.
In addition, customs authorities can take a rather aggressive approach on transfer pricing if they believe that the related parties may be manipulating the transfer price to reduce or minimize import duties, and closely scrutinize all related party payments, including those made for services. For example, adjusting the selling price from $100 to $90 and calling the $10 payment a management fee without adequate support or justification.

In some cases, the unbundling of certain costs from a goods transfer price can represent a valid and legitimate duty minimization technique. An importer would need to ensure that such planning opportunities are carefully and diligently managed.

5. Transfer pricing adjustments: An importer will often neglect to consider the impact on the customs valuation of imported goods further to periodic transfer pricing adjustments. For example, upward transfer pricing adjustments resulting in the increase of cost of goods sold must be reported to customs even when there is no loss of revenue. Failure to do so could result in significant penalties.

Conversely, certain downward adjustments may provide an importer with a duty recovery opportunity. Although customs valuation regulations worldwide typically consider such downward transfer pricing adjustments as post import adjustments and hence, not eligible for a duty refund, with some planning, this could be managed so that the importer can pay duties on the adjusted transfer price.

6. E-commerce: Internet sales represent another area with potential customs issues and concerns.

From a Canadian standpoint, internet sales to consumers can typically be categorized as “non-commercial” or ”casual” imports, and are potentially subject to provincial sales tax (PST). Companies doing business online or through the internet need to be aware of any indirect tax implications, including customs.

In addition, companies are sometimes unfamiliar with the regulations that come into play when dealing with foreign markets. For example, clothing and apparel imports into Canada require bilingual and product content labelling and origin marking. Companies cannot assume that a particular product that meets domestic requirements will also meet all relevant foreign regulations. Therefore, careful consideration must be given to all applicable regulations covering internet sales – irrespective of the metrics in play.

7. Other government department regulations: Importers must also be cognizant of other government department (OGD) regulations that are managed by customs authorities.

Canada Customs manages over 100 OGD regulations on behalf of various agencies and governmental departments, including import permits, food safety requirements, hazardous goods, energy consumption guidelines and numerous other requirements related to imported goods. Certain goods may be restricted, controlled or prohibited. An importer’s failure to ensure that imported goods meet all applicable requirements and regulations could result in product seizures, fines and/or penalties.

The costs involved to ensure that goods are compliant, along with delays in getting product to the consumer, can directly impact the importer’s bottom line. In addition to direct costs, reputational risk can also be of concern to an importer.

8. Customs compliance: In addition to reputational risk relating to non-compliance, customs views the importer of record as the party liable for compliance with customs and OGD regulations. Any resulting fines, penalties, seizures or negative publicity surrounding an importer’s negligence to comply with all customs-related regulations (including OGD requirements) will be at the importer’s expense.

Relying on third party service providers will not shelter an importer from issues and/or related non-compliance costs. Importers need to be fully aware of the commercial and legal implications with respect to the importation of goods, since executives risk being held personally liable and could face civil and criminal prosecution.

9. Supply chain issues: Customs-related issues relating to the supply chain structure in place need to be given careful consideration. On numerous occasions, a company has looked to change its product sourcing to reduce costs, only to realize that the resulting duty costs far outweigh any savings.

In addition, potential income tax savings resulting in the implementation of a particular transaction structure could very well be diminished or countered by the resulting import or duty costs.

Careful consideration for all contemplated supply chain structures and their underlying transactions need to be rigorously reviewed to ensure that all and any import, duty or compliance-related concerns are properly addressed.

10. Special Import Measures Act: Under the Special Import Measures Act (SIMA), Canada can impose extra duties on goods in order to fight unfair trade. Antidumping duties are extra duties designed to fight dumping – selling goods in the country of import at a price lower than the price they are sold at in the country of export, with certain adjustments.

For their part, countervailing duties are extra duties imposed on goods when the manufacture of the goods may be subsidized by a foreign government.

These kinds of domestic industry protection laws focus on the kind of goods, the country of manufacture and the manufacturer. The extra duties imposed by these measures can be significant — in some cases, as much as several hundred percent of the value of the goods.

An importer should therefore look to ensure that its goods are not subject to these additional duties. Further, an importer should request that its suppliers confirm the origin, the manufacturer and the precise nature of the subject goods being purchased (imported) to avoid any unpleasant surprises. Given the possibility of incurring additional duty costs, sourcing goods from a low-cost country (wherein these additional duties may apply) may not make commercial sense.

It’s your duty to manage customs compliance

The importation of goods typically involves import duty and compliance costs. Therefore, it’s crucial for companies who rely heavily on the importation of goods to ensure that their importing operations are managed carefully, and are in compliance with all relevant regulations to avail themselves of potential planning opportunities.

Even in situations where no customs duties apply on any specific import, if the value for duty is not the proper value for duty, the rules allow for interest and penalties to be applied on the value of the goods. This can result in material exposure for many importers who believe the value for duty is not an issue when the goods imported into Canada are not subject to customs duties.