Mark Neville
Mark Neville Mark K. Neville, Jr., LL.M. (International Legal Studies), NYU, is Principal of International Trade Counsellors. He has considerable experience in the field of international trade and customs affairs and international commercial transactions. He has successfully advised numerous United States and foreign-based companies on strategic matters of planning, compliance and enhanced efficiencies.

Customs Planning’s Ol’ Reliable: Duty Drawback

Customs Planning’s Ol’ Reliable: Duty Drawback

The granddaddy of all customs planning is duty drawback. So deeply rooted is drawback, that many will refer to customs planning opportunities in a generic manner as “drawback.” While that would be a mistake, and while some other planning techniques may provide equal or better benefits, duty drawback may yet be the best way forward for many importers.

Background

The duty drawback program was embodied in the Tariff Act of 1789, the first substantive law ever enacted by the US Congress. This tariff law was put forward by Alexander Hamilton as the major source of revenue for the fledgling United States, but the US was willing to forego duty in the hopes of boosting commerce. The notion was that 99% of the customs duties that had been previously paid on imported goods should be drawn back, i.e., remitted or refunded, when the goods were re-exported within one year. In such a way, US commerce would be more competitive in foreign markets since there would be no need to mark up the sales price so as to recoup the cost burden of the duty.

Needless to say, drawback has undergone numerous revisions since its inception. The statutory provision for drawback is found at 19 USC § 1313, with the applicable regulations at 19 CFR Part 191.1 Note that certain excise taxes paid on imported spirits, wine and beer are also eligible for drawback.2

Three Categories of Drawback

There are three general categories of drawback:3

  • Manufacturing drawback
  • Unused merchandise
  • Rejected merchandise

Moreover, there are certain variations within each category, so that there could be a special drawback regime for a specific product line, such as finished petroleum derivatives,4 applicable time limits may vary from one category type to another or the importer may have the option of substituting products or using accounting conventions such as first in/first out (FIFO) or last in/first out (LIFO).

Note that, in general, the right to claim duty drawback is the exporter’s, not the importer’s, who paid the customs duty at the time of importation.5 The rationale is simple—the assumption is that the importer has already got his reimbursement as he built the duty into the cost to his customer in the United States.

Manufacturing Drawback

There are two species of manufacturing drawback:

  1. Direct identification which requires that the imported articles are used in the manufacturing process and are re-exported, with no substitution allowed.6
  2. Substitution which permits the drawback of duties paid on imported merchandise so long as the goods which were actually used in manufacturing the finished products which were subsequently exported are of the “same kind and quality.” Since 2016, the substitution standard has been effectively defined by the merchandise being classified within the same 8-digit HTS subheading.7

In turn, “same kind and quality” means the articles are commercially interchangeable.8 Drawback is limited to 99% of the duties paid. The time limits are such that the imported merchandise and the substituted merchandise must be used within three years of receipt by the manufacturer of the imported merchandise and the exportation must take place within five years of the importation.9 Note that the goods cannot be used in the United States after manufacture.

How does CBP define “manufacture,” one might inquire? The definition10 is consistent with the notion of “substantial transformation” in the context of country of origin and labeling principles: the merchandise is made into a new and different article having a distinctive name, character or use.11 But the concept is broadened, to comport with case law, and the operative phrase is “manufacture or production” so as to embrace the merchandise having been made fit for a particular use.12

There are two basic types of manufacturing processes allowed, and the drawback claimant has the option of either following one of the general drawback manufacturing rulings, in which CBP has set forth the commitments on a product-specific basis (e.g., component parts, flaxseed, burlap or other textile material) or to work under a specific manufacturing drawback rulings for which application is made to CBP Headquarters. The general rulings are listed and described in 19 CFR Part 191 Appendix A, while the requirements for the specific rulings are set forth in Appendix B.

Normally, duty drawback requires a strict “daisy chain” tracing the product from importation through delivery to another party to a manufacturer and on through exportation. These transfers are established through the use of certificates of delivery13 and certificates of manufacture and delivery14 and are set forth on Customs Form 7522. There is also an option for a “principal/agency” operation as an alternative to the use of the delivery certificates when a contract manufacturer is employed.15

The requirement to establish the appropriate “yield” of the subject merchandise in the manufacturing operation, to account for the subject merchandise, places a high premium on inventory control software. We see this requirement in other customs situations, too, such as in foreign trade zone manufacturing. One popular software solution is offered by Dutycalc Data Systems, but there are other solutions in the marketplace as well.

When speaking exportation, we must be mindful that destruction is an alternative to exportation. Destruction is a defined term, meaning complete destruction so that the merchandise or articles have no commercial value.16 The statute was amended in anticipation that the destruction process might yield some valuable waste, which must be deducted from the value of the imported merchandise.17

Unused Merchandise Drawback

The statute sets forth the requirements for “unused merchandise” drawback which, broadly stated, allow for drawback if the imported merchandise is exported or destroyed within three years of importation.18 Merchandise which is commercially interchangeable with the imported merchandise may be substituted.

The statute specifically lists a number of operations which do not constitute manufacture or production and, thus, disqualifying “use,” of the imported merchandise. These operations include many of the same non-manufacturing “manipulations” which are allowed in a customs bonded warehouse or which are permitted operations incidental to assembly abroad of fabricated US components.19

In the case of substitution unused drawback, the same 8-digit HTS subheading must apply to the imported and the exported merchandise, the exported goods must have been in the possession of the drawback claimant,20 but the non-substitution drawback claimant may be either the exporter or a party, either the importer or an intermediate party, to whom the right to claim drawback has been endorsed by the exporter.21

Since the use of a substitution technique makes for a much easier and flexible program, it is important that the drawback claimant establish that the goods are determined to be commercially interchangeable. The regulations provide for the issuance of formal rulings by CBP or nonbinding predeterminations from the appropriate drawback office or the submission on the point as an integral part of the drawback claim.22

As further evidence of the close scrutiny and control that CBP applies to the entire drawback process, we must be mindful that, for unused merchandise, at least 2 working days’ prior notice of intent to export or destroy must be given to CBP.23 This requirement may be waived by the drawback office where claims are being filed.24

Rejected Merchandise Drawback

For imported merchandise that is rejected by the importer, duty drawback is available upon the exportation or destruction of the merchandise.25 The defective state of the merchandise may be shown by means of an acknowledgment by the foreign supplier.

The subtitle of Section 1313(c) is “Merchandise not conforming to sample or specifications” but this is actually a misnomer. There is actually a right to claim drawback for goods that had been imported and ultimately sold at retail by the importer, or the person who received the merchandise from the importer, and for any reason returned to and accepted by the importer, or the person who received the merchandise from the importer.26

For claims in this Subpart D of the regulations, the prior notice of intent to export or destroy must be provided at least five working days prior to the anticipated date for such event.27 A claimant for unused merchandise drawback under 19 U.S.C. 1313(j) may apply for a waiver of prior notice of intent to export merchandise under this section.

Drawback’s Drawbacks

The drawback program has one major negative aspect, and that is its negative cash flow. The idea of paying the customs duty first and getting a refund only after the later exportation or destruction of the merchandise is one that many importers will want to avoid. Accelerated drawback payments28 would lessen the negative impact.

Those importers may turn, instead, to the use of customs bonded warehouses or foreign trade zones or to the use of temporary import bonds (TIBs).29 To be sure, each of those alternatives has aspects that may disqualify their use by an importer. The use of bonded facilities requires a high degree of control over the goods, starting with the import process itself. In fact, with many imported goods not having been directly imported by the company, but instead having been purchased in the United States from another party, duty drawback may be the only alternative.

Moreover, a TIB requires that all of the goods must be re-exported. Duty drawback gives greater flexibility.

Another negative aspect to duty drawback is the intense documentation required by CBP before the drawback refund is validated. This requires a great deal of cooperation from vendors and others to ensure, for example, that proper certificates of delivery are made available. Many drawback claimants will have to agree to share some part of drawback refunds for this cooperation, despite the vendors’ generally having been made whole already.

Finally, NAFTA legislation imposed a limit on the use of substitution drawback. Shipment of goods to a NAFTA country did not count as a qualifying exportation.30 In addition, NAFTA legislation imposed a limit on eligible drawback refunds for shipments to NAFTA countries. The refund is the lesser of the duties paid in the United States and the duties owing when imported into the other NAFTA territory.31 All of these NAFTA provisions were adopted when USMCA superseded the NAFTA.

Conclusion

In spite of these possible negative aspects, duty drawback remains a viable alternative and importers and exporters would be remiss if they did not consider taking advantage of the program and filing at one of the several drawback centers. Such a review may show that drawback is the optimum customs planning choice.

As a final administrative note, the drawback claim32 must be e-filed at a designated drawback office.

⁂

This article was originally published in the Journal of International Taxation

Any content provided by our bloggers, contributors, or users is their opinion, and they are responsible for the accuracy, completeness, and validity of their statements. Trade Duty Refund does not guarantee the accuracy or reliability of any opinions expressed in the content.

  1. Except for the regulations which pertain to limitations imposed under USMCA, found at 19 CFR Part 182 Subpart E, 19 CFR §§ 182.41-55. The NAFTA drawback regulations are in 19 CFR Part 181 Subpart E, 19 CFR §§ 181.41-54. ↩

  2. 26 USC § 5062. ↩

  3. To be sure, there are some quite specific drawback categories such as imported salt for curing fish, jet aircraft engines or materials for construction and equipment of vessels built for foreigners. ↩

  4. 19 USC § 1313(p). ↩

  5. 19 CFR §§191.28 and 191.33. ↩

  6. 19 USC § 1313(a). ↩

  7. 19 USC § 1313(b). ↩

  8. 19 CFR § 191.2(x). ↩

  9. 19 USC § 1313(i). ↩

  10. 19 CFR § 191.2(q)(1). ↩

  11. See, e.g., 19 CFR § 134.35(a) following, e.g., Anheuser-Busch v. United States, 207 US 556 (1907). ↩

  12. 19 CFR 191.2(q)(2). ↩

  13. 19 CFR §§ 191.2(c) and 191.10. ↩

  14. 19 CFR §§ 191.2(d) and 191.24. ↩

  15. The requirements for this treatment are set forth in 19 CFR §191.9. ↩

  16. 19 CFR § 191.2(g). ↩

  17. 19 USC § 1313(x). ↩

  18. 19 USC 1313(j)(3). ↩

  19. Cf. 19 USC § 1313(j)(3) and 19 CFR § 19.11 and 19 CFR § 10.16. ↩

  20. 19 USC § 131 (j)(2). See Cargill Citro-America, Inc. v. United States, 395 F.Supp.2d 1222 (CIT 2005). ↩

  21. 19 USC § 1313(j)(1). ↩

  22. 19 CFR § 191.32(c). ↩

  23. The notice is given with the use of CF 7533. 19 CFR § 191.35. ↩

  24. A claimant for unused merchandise drawback under 19 USC § 1313(j) may apply for a waiver of prior notice of intent to export merchandise under 19 CFR § 191. ↩

  25. 19 USC §1313(c)(1)(C)(i), 19 CFR § 191.41. ↩

  26. 19 USC §1313(c)(1)(C)(ii). ↩

  27. 19 CFR § 191.42(c). ↩

  28. Available under 19 CFR § 191.92. ↩

  29. See 19 CFR § 10.31. ↩

  30. 19 USC § 1313(j)(4)(A). ↩

  31. 19 USC § 1313(n). ↩

  32. Note that drawback claims are actually in the form of customs entries and are filed with CF 7551. 19 CFR §§ 191.2 (j) and (k). ↩