Trade, Lawyers and Loopholes
Please note this blog post was published over 12 months ago and so may not include the most up-to-date information, for example where regulation around investing has changed.
Trade tariffs implemented by the United States and China have put significant pressure on manufacturing causing it to slow. However, some interesting trade flow dynamics are emerging.
• The value of US imports from China, the top solid line stretching back almost 25 years shows strong growth. However, the dotted line projection for 2019 indicates a very marked drop in imports is expected.
• Exports to China from the US, the middle solid line, has also grown over the last 25 years, but note how much less the US sells than it buys from China. This causes anger in the US. It’s trade with China is unbalanced and exports are growing at a slower pace than imports. The value of exports is expected to fall (the dotted line), but not as precipitously as imports.
• The net effect on the trade deficit over the last 25 years has been bad for the US, but looking ahead the deficit, the dotted line projection, is expected to narrow. Imports from China are now falling at a much faster rate than exports. Faltering activity is not exactly what Donald Trump wanted because his main aim was to expand trade by getting China to buy more US goods. Nonetheless, a shrinking trade deficit is an important step in the right direction.
Balance of Trade in Manufactured Goods with China
Source: United States Census Bureau, July 2019
At the beginning of his presidency President Trump made it clear he would do whatever it took to forge a legacy that involved reducing the longstanding trade deficit with China. Evidence from our chart points to a trend shift underway; unfortunately, at the cost of slowing growth in trade. To avoid trade activity slowing further both parties called a truce. At the G20 in Osaka Trump and Xi agreed to temporarily withhold more tariff hikes and to restart trade talks. The suspension of hostilities does not rule out the risk of further tariff hikes, should these discussion falter, but it is a positive step. The US are now aiming to pressure China to buy more goods, particularly agricultural products.
Throughout the period of trade talks, US companies have been getting on with the job of doing business. In the private sector business leaders have taken matters into their own hands by hiring some of the top legal attorneys in the country asking them to look for ways to avoid tariffs but remain within the law. We explore 4 examples below;
1. First Sale Rule: In China the supply chain, from the manufacturing plant to the distributor, has multiple levels before goods even leave China. This layering increases the re-saleable price with each counterpart taking a slice of the margin. Lawyers in the US have now cottoned on to the First Sale rule where tariffs can be applied at the point of first sale (price paid to manufacturer) and not necessarily later in the process.
Example – If a $10 item moves from manufacturer to distributor and is marked up to $15, US importers pay 10% producing $1.50 duty on this item. The First Sale rule changes this if the US importer can prove the point of sale occurred at the manufacturer i.e. only paying $1.00. For large volume companies this can have a significant impact on import costs.
Currently, only 2.4% of US importers use the First Sale method because tracing back through the members of the supply chain, and persuading them to provide a complete and accurate audit trail for all goods, is bureaucratic. With multiple links in the chain participants unwilling to share this information for commercial sensitivity purposes make it a tricky business to satisfy US trade officials who require an audit trail. However, radically improved technology, automation and tracking is coming along making this more achievable.
2. Tariff / Operational Engineering: In 2018 President Trump imposed a 20% import duty on the first 1.2 million washing machines imported into the US from China each year, with tariffs increasing to 50% on subsequent units above this quota. Currently each washing machine is imported fully assembled. However, if imported as component parts, and reassembled onshore in the US, the tariff paid is significantly lower. This approach also applies if assembly takes place outside the US; and the ‘Chinese’ washing machines are then exported to the US from a domicile where trade tariffs do not apply. The component reassembly approach extends beyond washing machines and other household white goods making this a realistic workaround.
3. Customs Bonded Warehouses: The option here is to utilise bonded warehouses for the storage of goods imported from China. After a period, typically up to five years, no duty is collected until after the goods are removed from the warehouse for domestic sale. This staged release of goods allows businesses to improve their cashflow by avoiding paying the duty fee on the full quantity all at once. If goods are sold internationally the duty is cancelled altogether.
4. Section 321 De Minimis: For small businesses, the 321 de minimis regulation allows goods up to the value of $800 (raised from $200 in 2016) to enter the US free of customs duty. This has been of great benefit to the eCommerce market, but with a limit of only one shipment per customer per day the potential benefits are limited.
Trade data shows that tariffs are putting downward pressure on trade between the US and China. That said, the US trade deficit with China is shrinking. Simultaneously US business are finding various loopholes to avoid paying new tariffs proving that business leaders think-smart during politically driven chaos. US companies are demonstrating inventiveness in the face of unpredictable and unpleasant events. In the UK the media fret about Brexit uncertainty and political indecision associated with an unknown future UK trading relationship with the EU. If tariffs are applied, it seems likely that UK companies will begin to work out ways to overcome any barriers or tariffs. US companies battling new tariffs are proving this is possible.