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Supply chain snarls drive new uses for Foreign Trade Zones (FTZ)

Due to mounting disruptions, free zones and economic zones are gaining in popularity all around the world—which is causing some confusion about the specifics of the U.S. Foreign Trade Zone program. Our FTZ consultant shares some of the basics and the overall benefits these zones can bring to your supply chain operations.

The Foreign Trade Zone (FTZ) program, originally created during the Great Depression (1934), was established by Congress to meet tariff challenges faced by U.S. importers in order to help level the global playing field and support competitiveness of companies employing U.S. workers.

Since its inception, Congress continued to adapt the program to meet other inequities faced by companies in the United States, always with employment and economic prosperity in mind. And today, more and more firms are using the program to address supply chain issues and economic factors.

The foundation of the program is the idea that a zone is created around a facility that establishes the location to be outside of U.S. commerce. As such, goods from both domestic and foreign suppliers can be brought into a facility, and there is no duty paid on the goods sourced from non-U.S. locations until those goods are removed from the zone destined for a location within U.S. commerce.

Basis of the FTZ program

The facility must, of course, have stringent inventory controls in place to receive such benefits and ensure the proper duties are in fact paid upon removal from the FTZ.

Those qualifying with the Department of Commerce and the Department of Homeland Security to be activated with such a designation receive a variety of benefits, including deferral of duty payments and elimination of duty in certain circumstances. Lesser-known aspects of the program also make it possible to manage things like quotas as well as to improve supply chain velocity through direct delivery.

Duty deferral: Import duties on goods made or stored in an FTZ aren’t paid until the goods are shipped to a location in the United States. This means companies can defer the payment of duties until the merchandise is sold, matching expense with revenue. This is a major benefit for both manufacturing and distribution companies, especially those subject to anti-dumping, Section 301, or Section 232 additional tariffs on their imported merchandise.

As trade remedy tariffs continue to be utilized, the cash flow benefit of FTZs is more attractive than ever before. Goods that were once low duty or even possibly duty-free now require as much as 25% of the value of the goods be paid in taxes.

For some companies, being able to delay payment of that bill as long as possible is critical at a time of possible recession. Many of the previously utilized exclusions to these tariffs are expiring without renewal under the current administration, and importing companies are finding that they have an unexpected bill that is not yet matched with the ability to recoup the cost in the price of goods sold. Delaying that payment, then, becomes mission critical.

Supply chain delays including port congestion, equipment shortages, and supply unavailability also increases carrying costs as on-hand inventory increases to buffer the challenges.

The FTZ program’s ability to help defray the cost of extra inventory through duty deferral may not have been a consideration in the past, but it’s much more important now. And a company may also receive a benefit on domestic inventory and equipment if your state has ad valorem taxes on these materials.

Duty elimination on exports: Because the FTZ is outside U.S. commerce, finished goods brought into a warehouse operating as an FTZ can be exported to any country without paying any U.S. Customs duties or fees. Warehouses established as FTZs in the United States, employing U.S. workers, can then be used to house goods for all North America and beyond.

This is preferable for the U.S. economy versus having those same companies establish smaller warehouses in separate countries in order to mitigate duties paid on goods destined for non-U.S. locations.

This is significant for firms wishing to remove the delay of ocean shipping and be closer to the end consumer, especially with the increased adoption of e-commerce courtesy of the global pandemic.

Imported components that are manufactured into finished goods in an FTZ can also be exported outside of North America without paying any U.S. Customs duties or fees. In fact, FTZs are the only way a U.S. factory can avoid paying anti-dumping, section 301, or section 232 additional Customs duties on their merchandise for export.

Another duty elimination option for destruction: Imported goods must sometimes be destroyed, and their commercial value is never realized. Paying duty on such goods and then proving the destruction for drawback is time consuming, and the opportunity cost of those duties is potentially high.

The FTZ program’s ability to help defray the cost of extra

inventory through duty deferral may not have been a

consideration in the past, but it’s much more important now.

If instead those goods are brought into a zone in foreign status and then later destroyed inside the zone, no duties are ever paid. Also, if goods are found to be of lesser quality or can’t be sold as planned and must be sold for a scrap value rather than the original value, duty can be paid at the lower value instead of the full import value with proof of the value reduction.

In the case of steel and aluminum, because much of these imported commodities is subject to Section 232 tariffs, this is an attractive benefit of FTZs because the use of these materials in manufacturing and distribution inherently results in scrap. If the steel or aluminum is imported, paying less duty for the lower value scrap makes a noteable difference.

Managing quotas: More recently, U.S. importers have seen an increase in the use of quotas and tariff rate quotas to limit imports of certain commodities. FTZs can help mitigate this supply chain challenge as well.

Quotas set an upper limit on the amount of a good that can be imported in a period of time. Once that quantity is reached in totality across the country, no more of that commodity can be imported until the time period concludes and the quantity is reset.

Tariff rate quotas (TRQ) work similarly, but raise the duty percentage on the goods once the quota limit is reached rather than precluding further imports completely. All these import limitations are based upon the amount of goods entering the U.S. commerce. So, if the quota quantity has been reached, the goods can be admitted to an FTZ duty free to await the resetting of the quantities and then be entered into the United States.

Direct delivery and speed to market: One lesser-known benefit of FTZs is about supply chain speed rather than duty mitigation, and that is something called direct delivery. Applied for during the activation step, direct delivery is an FTZ privilege that may be granted by Customs and Border Protection (CBP) to allow zone operators to move goods immediately from the port of unlading directly to the zone using in-bond procedures.

The goods flow seamlessly to the zone for counting and admission at which time a full reporting of the goods is made to CBP, rather than being a requirement for the goods to leave the port. Once admitted to the zone, the goods are ready for use in manufacturing or to be shipped to the end user. In this day of port congestion and delays, anything that gets your goods moving faster is a benefit.

Is an FTZ right for you?

Free zones and economic zones are gaining in popularity all around the world, and this is causing some confusion about the specifics of the U.S. foreign trade zone program—so the differences are worth noting. Unlike economic zones or free zones of other countries, a U.S. foreign trade zone does not require a company to move operations to a designated facility to achieve these savings.

In the United States, inclusion in the program requires a review of the proposed economic benefit by the U.S. Department of Commerce via an application filed by a representative of the FTZ Board that is local to the area, called the grantee. This ensues the proposed FTZ will contribute to the public good in that community.

Next, the Department of Homeland Security confirms the physical security and inventory procedures of the facility. Within the department, Customs reviews a written application describing the specific activities to be performed in the zone and conducts a site visit to inspect the area to be designated as well as the procedures that the operator plans to use to ensure compliance. After the process is completed, CBP issues a letter of activation outlining which activities can take place in the zone.

Last, if there are plans to conduct production in the zone, a production notification must also be filed with the U.S. Department of Commerce. If approved, this will allow the zone to perform manufacturing and kitting.

Alternatively, a company wishing to seek FTZ benefits might enlist the services of a third party to operate the FTZ at the company’s location. Another option is to choose to use a site operated by that third party instead of its own facility to process the goods and receive the cost savings outlined above. These two options can lower the costs of getting started in the program.

These are just a few benefits of the FTZ program. For a more involved ROI analysis, it’s important to look at a company’s complete supply chain, all current and potential sourcing options, and the importing challenges faced.

But, for any company importing goods into the United States, it is worth the time to review the benefits of the FTZ program

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