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Beware the Perils of Transshipment

By Frederic Rocafort, Harris Bricken

The imposition by the USA of tariffs of up to 25% against many Chinese products (part of the “Trump tariffs” and the broader US-China trade war) has left many international businesses that source from China scrambling for alternatives. These tariffs, imposed under the authority of Section 301 of the Trade Act of 1974, affect products covered by thousands of subheadings in the Harmonized Tariff Schedule of the United States (HTSUS).

In some instances, companies have been able to find alternative sources in other countries for the products they need. Vietnam has probably been the greatest beneficiary of the trade war, with its exports to the US up nearly 36%, year over year, in 2019, according to US Department of Commerce data. Other companies have opted to reengineer their supply chains, shifting some production activities to other countries, in the hope their products will at some point pass over the threshold of “substantial transformation” into a non-Chinese product.

According to the landmark decision in US vs Gibson-Thomsen Co. (1940), a substantial transformation occurs when a new and different article of commerce emerges from a production process with a new name, character, or use different from that possessed by the article prior to processing. Later court decisions, however, have muddied the waters. As acknowledged by the US Court of International Trade (CIT) in Energizer Battery, Inc. vs US (2016), “in addition to name, character, and use, courts have also considered subsidiary or additional factors, such as the extent and nature of operations performed, value added during post-importation processing, a change from producer to consumer goods, or a shift in tariff provisions.” The Energizer Battery court itself noted that the application of additional factors was “not consistent, and there is no uniform or exhaustive list of acceptable factors”.

US Customs and Border Protection (CBP) rulings – which are publicly available – can provide some clarity, applying the law to real-life scenarios, though the facts in an importer’s situation are often not suffciently analogous to those in any CBP ruling. Importers can request a ruling based on their own situation, but they run the risk of being stuck with an explicit determination that their product is in fact of Chinese origin.

Faced with this legal tangle, some businesses decide they will just make it look like their product is from a third country by transshipping it from China to the US via a third country. In some cases, this transit may be accompanied by minor production activity, such as repackaging or painting. When it comes time to export the product to the United States, the product is marked as having been made in the third country – and not in China. Current hotspots for transshipment include Vietnam, Malaysia, and the Philippines.

This may seem like a clever approach, but such practices are of course illegal. Moreover, the penalties that could result are severe, including criminal convictions. Consider the smuggling statute (18 U.S.C. § 545), which states that anyone who “knowingly and willingly … passes through the customshouse any false, forged, or fraudulent invoice … shall be fined … or imprisoned [for] 20 years, or both” (emphasis supplied).

Being fully aware of the games some importers are playing, CBP is paying increasingly close attention to shipments of “Not Made in China” product. In addition to its own discoveries, CBP can rely on information provided by whistleblowers. Section 3730 of the False Claims Act (FCA) (31 U.S.C. §§ 3729 et seq.) provides for a private right of action, allowing relators (a fancy term for whistle-blowers) to benefit handsomely from their information.

Under the FCA, if the government chooses to prosecute an action based on the related information, the private party will be entitled to 15%–25% of the recovery. Meanwhile, if the government declines to prosecute the case, the private party can go ahead on its own, and be entitled to 25%–30% of any recovery. To give an idea of the recovery amounts implicated, my law firm represented the relator in a case where the importer settled with the US Department of Justice for USD 62.5 million. In other words, these cases can be both lucrative for the party that initiates the action and extremely costly for the company that violates the transshipment laws.

In practical terms, this means importers who engage in illegal transshipping must worry not just about CBP inspectors, but also about their competitors, disgruntled employees, service providers, and essentially anyone who may be on to them. With all this in mind, the wise course is to avoid the games and follow the law. The costs associated with finding alternative sources, modifying supply chains, or the tariffs themselves may sting, but not as much as massive penalties and jail time.

Frederic Rocafort

Frederic Rocafort

GGI member firm
Harris Bricken
Law Firm Services
Portland (OR), Seattle (WA), USA
T: +1 206 224 5657
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Published: GGI Insider, No. 107, May 2020 l Photo: unikyluckk -

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