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One of the consequences of the globalized economy is that our own backyard has become (quite literally) an international playing field. While the global economy may be the salvation of some industries, such as big tobacco and the athletic shoe industry, for small and mid-sized U.S. distributors and manufacturers, it can be difficult to compete in local markets against multinational companies that reap the benefits of offshore manufacturing.
For companies whose operations involve the importation of foreign merchandise, one way to level the playing field is through federally licensed Foreign Trade Zones (FTZs). Doing business in an FTZ offers a variety of economic benefits, including duty exemption or deferral, inverted tariffs, lower administrative costs resulting from streamlined customs procedures and the exemption of exports from state and local inventory taxes. There are approximately 250 general-purpose FTZs and more than 450 approved subzones in the United States, with at least one FTZ in each state.
What Is an FTZ?
An FTZ is a defined geographical area within the United States, located in or near a U.S. port of entry, that has been licensed by the Foreign-Trade Zones Board to be treated, for customs purposes, as if it is outside of the United States. The FTZ designation enables domestic storage, distribution and approved manufacturing activity involving foreign merchandise to take place prior to formal customs entry into the United States.
The FTZ program was created by the Foreign-Trade Zones Act of 1934 to “expedite and encourage foreign commerce.” The Board—comprised of the Secretary of the Treasury and the Secretary of Commerce, who serves as chairman of the Board—was formed to grant FTZ licenses. Once a license has been granted, the site must then be approved for FTZ activity by U.S. Customs and Border Protection (CBP) before any zone activity may take place. Local CBP officials also control and supervise all zone activity.
Although retail trade is prohibited in FTZs, merchandise may be assembled, exhibited, cleaned, manipulated, manufactured, mixed, processed, relabeled, repackaged, repaired, salvaged, sampled, stored, tested, displayed and destroyed. Manufacturing, processing and any activity that results in a change in the tariff classification of the foreign merchandise must be approved by the Board.
The economic benefits of operating in an FTZ fall into three main categories: elimination of customs duties and other taxes, decreased or deferred customs duties, and reduced administrative costs.
Elimination of Customs Duties and Other Taxes
Firms operating in an FTZ can eliminate customs duties altogether on foreign merchandise that enters an FTZ but is never placed into U.S. commerce (i.e., merchandise that is either exported to a foreign jurisdiction directly from the FTZ or destroyed once it arrives in the FTZ). For example, widgets that are manufactured in a foreign jurisdiction, imported to a non-FTZ site, stored in a warehouse at the site of entry into the United States and eventually exported to a foreign jurisdiction are subject to customs duties. However, if the same widgets are imported directly to an FTZ, stored in a warehouse located in the FTZ and then exported to a foreign jurisdiction, they would not be subject to any customs duties because the widgets would be deemed not to have entered into the commerce of the United States.
The same logic applies when foreign merchandise is imported into an FTZ and destroyed there. In other words, widgets produced in a foreign jurisdiction and imported to a U.S. site located outside of an FTZ, then determined to have no commercial value and destroyed at the site of entry, are subject to customs duties, regardless of the fact that they were later destroyed by the importing firm. Doing business in an FTZ allows a firm to avoid those duties altogether.
It is also worth noting that all tangible personal property imported from a foreign jurisdiction into an FTZ is exempt from state and local ad valorem taxes (defined as taxes, duties or fees that vary based on the value of the products, services or property on which they are levied).
Decreased or Deferred Customs Duties
Firms engaged in Board-approved manufacturing in an FTZ incur additional savings by way of decreased customs duties on the merchandise they import. As a result of the many multilateral trade agreements the United States has entered into over the years, situations often arise in which foreign components are dutiable at a higher customs rate than the finished product. Manufacturing firms operating in an FTZ benefit from what is known as an inverted tariff, meaning they pay customs duties on the component parts at the lower of (i) the rate applied to the component part, and (ii) the rate applied to the finished product. For example, if foreign merchandise used to manufacture a finished product has a value of $100 and a customs duty rate of 10%, but the finished product has a customs duty rate of just 1%, a firm operating within an FTZ would only pay customs duties of $1.00 (or 1% of the value of the components) on the component parts.
Another benefit for firms engaged in Board-approved manufacturing within an FTZ is the ability to pay customs duties only on the amount of foreign merchandise put into U.S. commerce via the finished product and only when it leaves the FTZ. For example, foreign merchandise that is imported to a non-FTZ site for use in a manufacturing process in which 25% of the merchandise is destroyed would be subject to customs duties on 100% of the value of the merchandise. If the merchandise had been imported into an FTZ and manufactured there, the firm would only pay customs duties on 75% of the foreign merchandise (the portion remaining in the finished product).
Operating in an FTZ also gives firms the ability to defer payment of customs duties until merchandise leaves the zone and enters U.S. commerce. This is especially useful in FIFO (first-in, first-out) inventory systems, where the first items brought into the zone are also the first to leave. It is also important to note that no interest is collected on the average inventory on hand, and firms are entitled to a one-time duty deferral on the average foreign inventory on hand during the first year of operation in an FTZ.
Reduced Administrative Costs
Companies operating in an FTZ have the added benefit of significantly streamlined entry procedures. Foreign merchandise imported to the United States in an FTZ is delivered directly to the operations site, eliminating customs exams and the associated delays.
Firms operating in an FTZ also enjoy reduced merchandise processing and brokerage fees, and are able to eliminate the hassle of drawbacks because goods imported and exported through FTZs are processed once a week, regardless of how many shipments are actually received. Therefore, a firm operating outside of an FTZ will pay a merchandise processing fee (MPF) equal to 21% of the value of the merchandise (up to $485) on every shipment received. A firm operating in an FTZ will pay that fee one time each week that it receives a shipment, regardless of how many additional shipments it receives that week.
Benefits Come with a Price
While FTZs offer significant economic benefits to operators and manufacturers using foreign merchandise in their business model, there are costly and time-consuming compliance requirements that limit the program’s value for some companies. Therefore, firms considering the FTZ program should undertake a detailed cost-benefit analysis.
Under the Foreign-Trade Zones Act, the Board may issue grants of authority (licenses) to establish, operate and maintain FTZs to port authorities, municipalities and other entities authorized to apply for zone status under the applicable state legislation. Upon issuance of an FTZ license, the applicant becomes known as a “grantee” and will act as the public representative of the zone going forward. The grantee is responsible for submitting all zone modification applications and subzone applications to the Board, and is also ultimately responsible for any unpaid customs duties, fines and penalties incurred by zone users if the zone operator is unable to pay them. In most cases, the grantee will contract out the operation of the FTZ to the zone users or a third-party operator. The zone operator must be bonded and has direct customs liability for the FTZ, as well as direct responsibility for inventory control.
There are two types of FTZs: general-purpose zones and subzones. General-purpose zones are designated physical areas located within or adjacent to a CBP port of entry. Open to multiple users, they are most commonly used for warehouse and distribution activity, although manufacturing is permitted. Subzones—usually an individual user’s facility at which manufacturing, processing and distribution activities occur—are special-purpose ancillary zones authorized by the Board for a specific activity that (i) cannot be accommodated within an existing general-purpose zone, (ii) will result in a significant public benefit and (iii) is in the public interest. The length of the application process, as well as the cost involved, varies depending on whether the applicant is seeking a new zone license or merely activation or modification of an existing zone; whether the license is for a general-purpose zone or a subzone; and whether or not the intended use involves manufacturing. Approval of most application types takes approximately 10 to 12 months from the date of submission to the Board.
Once the required application type is known and the associated costs and time frame for approval have been determined, the potential user will need to do a detailed analysis of (i) the costs of compliance with the program, including preparing and submitting the user/operator application to the Board and CBP, and (ii) the potential savings. If the cost-benefit analysis indicates that an FTZ makes sense, then the firm would need to submit its application to the zone operator for review. Following approval by the operator, the application will be submitted to the grantee for review, and ultimately the grantee will submit it to the CBP and the Board for approval.
Although there are significant costs to participate in the FTZ program, under the right circumstances, Foreign Trade Zones can provide tremendous savings, thereby enabling small and mid-sized U.S. firms to compete in the international marketplace, otherwise known as their own backyard.
© 2010 Much Shelist Denenberg Ament & Rubenstein, P.C.