Contributors

Eric P. Weiss

Principal

Small changes can make a big difference. Add drawstrings or pockets below the waist to a blouse and the import tax drops from 15.4% to 8.1% for a cotton version and from 26.9% to 16% for one made of polyester.

 

Introduction

During his campaign, Donald Trump promised that he would impose heavy tariffs on imported goods, particularly for China, Mexico, and Canada. Once elected, President Trump has lived up to his promise. There are various tools importers can use to address these tariffs. One such rule is called “Tariff Engineering” which, when properly done by importers, can reduce or even avoid a tariff. However, if improperly done, the importer can face substantial penalties as one major importer, the Ford Motor Company, recently learned.

How tariffs work

Companies that import goods from international trade partners pay the tariff fees to the United States Customs and Border Protection (“CBP”) at the port of entry within 10 days. The CBP collects the tariffs on behalf of the Department of Commerce. When a shipment arrives at a port in the United States, the “importer of record”, generally through a licensed customs broker, files entry documents relating to the goods with CBP. The “importer of record” is the owner or purchaser of imported merchandise or a licensed customs broker that has been appointed by the owner, purchaser, or consignee. (See 19 U.S.C. § 1484). An owner or purchaser is someone who has a financial interest in the transaction rather than a nominal interest (i.e. a related party to the transaction).

Tariffs are largely imposed based on the classification, origin, and valuation of imported merchandise.

Classification of Imported Merchandise

Classification of merchandise imported into the United States is determined according to the Harmonized Tariff Schedule of the United States (“HTSUS”), which is based on the international Harmonized Tariff System. The HTSUS is a complete product classification system in that it covers all potential types of imported merchandise. The HTSUS consists of 96 chapters grouped into 21 sections. It is broken down by headings, subheadings, and statistical breakouts. The classification for a particular type of product is assigned a number (in the format 1234.56.7890).

Country of origin of imported merchandise

The country of origin determines the goods’ eligibility for trade programs and treaties and is generally considered the country of manufacture, production, or growth of an article. Rules of origin are then applied to determine if goods are eligible for duty-free or reduced duties even though they may contain non-originating components. There are two basic types of rules of origin: preferential and non-preferential. While preferential rules apply to determine eligibility of merchandise under trade agreements or special legislation, non-preferential rules of origin generally apply in the absence of trade agreements.

The country of origin of merchandise is not necessarily the country from which the goods are shipped (the country of export). In the United States, non-preferential rules of origin employ the “wholly obtained” criterion for goods that are wholly the growth, product, or manufacture of a particular country. For goods that consist of materials from more than one country, the rules employ the “substantial transformation” criterion, which is typically based on a change in name, character, and use—meaning an article is considered a product of the country in which it has been substantially transformed into a new and different article of commerce with a name, character, and use distinct from that of the article(s) from which it was so transformed.

Valuation of imported merchandise

Valuation of imported merchandise is based on the date of importation and serves as the basis for assessment of applicable duties, taxes, and fees on imported merchandise. There are several methods of valuation, all of which are designed to determine the “commercial reality” of the transaction.

What is tariff engineering?

The blouse example noted at the beginning of this article is a simple example of tariff engineering. Tariffs are imposed on imported merchandise based on their condition (or classification) as entered. This has led importers in a variety of industries where high duties prevail to import products in unfinished or embellished forms to legally take advantage of classification provisions carrying a lower or free rate of duty. For instance, components imported separately may fall into an entirely different tariff provision than the finished product and may thus be excluded from a higher duty. So adjusting the condition upon importation can impact the classification and associated tariff rate for that merchandise.

In particular, importers can explore the possibility of reclassifying goods under different HTSUS codes if alternative classifications align with the goods’ composition or functionality. Adjusting the product’s design or composition at the manufacturing stage can also change its classification to a category with lower tariffs. This is known as tariff engineering, and it is a legitimate strategy for importers to lower their import duty obligations. For instance, components or subassemblies may be subject to a completely different duty rate than the finished product, or vice versa.

Tariff engineering is not tariff evasion and it is no per se illegal. It involves understanding how import duties are imposed based on design, production, and importation of merchandise to legitimately take advantage of lower duty rates. It may involve evaluation of materials used, chemical combinations, construction of the product, fiber content, and other considerations.

It is critical, though, that importers engage in legitimate design or manufacture adjustments and maintain thorough documentation. Inclusion of modifications that amount to artifice, disguise, or a fictitious product may negate any benefits. As discussed below, a recent massive settlement highlights that this strategy is subject to scrutiny. And under the Trump administration a more heightened level of scrutiny on tariff engineering is expected.

Legal basis for tariff engineering

Tariffs were a major revenue generator for the federal government from the country’s founding through the Civil War. (The federal income tax as we know it did not exist until 1913.) The second law passed by the first U.S. Congress in 1789 was “An Act for Laying a Duty on Goods, Wares and Merchandises Imported Into the United States,” which imposed tariffs on many imported goods, including a tax on tea from China, India and Europe that ranged from 6 to 12 cents per pound. But since World War II, the federal government has imposed tariffs sparingly. At all times, importers have employed creative means to avoid tariffs, including tariff engineering a process by which an importer can minimize duties by configuring a product so that its condition at the time of import allows it to be classified under a provision that offers a lower duty rate.

Long ago, in 1892 to be precise, the United States Supreme Court, in Merritt v. Welsh, held that tariff engineering is an acceptable practice. In Merritt the Court faced the issue of whether it was acceptable for an importer to add molasses to sugar to satisfy a color-based tariff provision subject to a lower duty rate. The Court ruled that the practice acceptable “so long as no deception is practiced, so long as the goods are truly invoiced and freely and honestly exposed to the officers of customs for their examination, no fraud is committed, therefore no penalty is incurred.”

Since 1892 the lower courts have consistently relied upon the Merritt precedent and its legacy of decisions to rule that tariff engineering a product to minimize duties is permissible, as long as all representations made to the government are accurate, transparent, and complete (to the extent required by law)—and no attempt is made to defraud the government by “artifice or deceit.” An example of an illegal artifice would be the creation of an artificial product—a product that exists only as a fiction to influence the classification.

Decisions issued in the wake of Merritt firmly established that a product is classifiable based on its condition at the time of import. This remains crucial to modern customs administration. In the 1974 opinion in Carrington Co. v. United States, the Court of Customs and Patent Appeals (“CCPA”) said “it is a well-established principle that classification of an imported article must rest upon its condition as imported.” In its 1987 opinion in Bantam Travelware, Division of Peter’s Bag Corp. v. United States, the Court of International Trade (“CIT”) looked at whether the addition of braided material to luggage was commercially significant enough to influence the tariff classification. The CBP claimed that the braiding was an improper attempt to avoid a quota by adding material to the luggage that otherwise would not have been added. The court’s decision was in CBP’s favor, but the opinion is silent as to the importer’s motive or tariff engineering per se, the court noted: “[CBP] suggests that [Bantam] began to construct certain importations with braid in an effort to avoid quota restraints, and to benefit from lower duty rates on luggage in part of braid. In this regard, [CBP] notes that the incorporation of braided materials into the subject merchandise roughly coincided with the institution of the aforementioned quota [and] reveal [Bantam’s] intent to employ only enough braid to obtain favorable tariff treatment.”

In 1989 the Court of Appeals for the Federal Circuit (“CAFC”) reinforced the condition-as-imported principle in Simod America Corp. v. United States, noting that “imported merchandise is dutiable in its condition as imported, except in the instance … of deception, disguise, or artifice resorted to for the purpose of perpetrating a fraud of the revenue; what is going to be done with it afterwards is not relevant.” In 1992 the CIT reaffirmed an importer’s right to tariff engineer a product in Tropicana Products, Inc. v. United States. There the court recognized the “fundamental right of an importer to so fashion his goods as to obtain the lowest possible rate of duty, absent any fraud, deception or artifice concerning the condition of the goods.”

Thus, tariff engineering is legal so long as the importer does not engage in deception, disguise or artifice solely for the purpose of evading a higher tariff. Improper attempts at tariff engineering can lead to disastrous consequences, as recently learned by the Ford Motor Company.

Consequences for improper tariff engineering

The Department of Justice (“DOJ”) has created a Trade Fraud Task Force to prevent trade fraud, including avoidance of import duties based on improper tariff engineering. The Task Force works with CBP and other law enforcement agencies to ensure compliance with U.S. trade laws. A recent settlement with the Ford Motor Company (“Ford”) is an example of how the Task Force and the DOJ combat improper tariff engineering.

In 2013 the CBP ruled that over the course of four years Ford continually violated United States customs laws by importing its “Transit Connect vehicles” with “sham rear seats and other temporary features to make the vans appear to be passenger vehicles,” thus allowing the company to pay a duty rate of 2.5 percent on passenger vans instead of the 25 percent applicable to cargo vehicles. As a result, the CBP determined that the hundreds of thousands of Transit Connect vehicles were subject to the 25 percent duty applicable to cargo vans.

As background, Ford manufactured the Transit Connect vehicles in Turkey and imported them into the United States. Although these vehicles were made to order and were ordered as cargo vans, Ford imported them with a second-row seat and declared the vehicles as passenger vehicle subject to the 2.5 percent duty. After clearing customs but before leaving the port, Ford (via a subcontractor) removed the second-row seat and makes other changes, delivering the vehicle as a cargo van.

The DOJ alleged that Ford’s actions were designed to “conceal from CBP at importation that the vehicles were ordered as, sold as, and intended to be used as cargo rather than passenger vehicles,” and a DOJ official asserted that the federal government “will not permit companies to evade duties by adding sham features to their products and then misclassifying them.”

Ford denied these charges and filed a lawsuit with the CIT. CBP took the position that the second-row seat “is an improper artifice or disguise masking the true nature of the vehicle at importation,” instead of what Ford argued was legitimate tariff engineering. The CIT ruled in Ford’s favor finding that “tariff engineering is a “the longstanding principle that merchandise is classifiable in its condition as imported and that an importer has the right to fashion merchandise to obtain the lowest rate of duty and the most favorable treatment.” In finding for Ford, the CIT found that the vehicles, at the time of importation, were “principally designed for the transport of persons” irrespective of the later modifications.

The CIT ruling was reversed by the CAFC in 2019. The CAFC held that the CIT failed to consider the “intended use” of the Transit Connect vehicles which were clearly for cargo and not for carrying passengers. The United States Supreme Court denied Ford’s petition for review of the CAFC decision. This led to a settlement in March of 2024. As part of the settlement, Ford agreed to pay $365 million to resolve the DOJ action. As part of the settlement Ford agreed to dismiss its case in the CIT. Ford also agreed that it will seek to avoid similar problems by requesting prospective classification rulings from CBP for new and significantly modified vehicles over the next five years.

Key Takeaways

Importers are encouraged to practice tariff engineering in order reduce duties placed on imported products. However, in light of President Trump’s emphasis on tariffs, and use of Executive Orders, it is possible that he could attempt to “outlaw” tariff engineering as a means of avoiding larger duties. Even if the practice is not outlawed, there is no doubt that the Trump Administration, through its DOJ and Task Force, will closely scrutinize and punish those importers who engage in questionable tariff engineering practices. As such, importers are encouraged to:

• Analyze current tariff structures and identify opportunities for cost reduction.
• Evaluate existing trade agreements and their implications on their supply chain.
• Assess the potential impact of regulatory compliance on operations.
• Build strategic partnerships with suppliers and logistics partners to enhance tariff engineering efforts.