THE FOREIGN-TRADE ZONES PROGRAM

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1 THE FOREIGN-TRADE ZONES PROGRAM By Greg Jones with FTZ Corporation About the Foreign-Trade Zones Program The U.S. Foreign-Trades Zones program is a federal trade program aimed at enhancing the competitiveness of U.S.-based companies engaged in international trade. Companies that use Zone procedures enjoy the benefits of relief from tariffs and other forms of inventory taxes on goods and materials during the time that such goods are within their Foreign-Trade Zone facilities. U.S.-based companies use the FTZ program as a tool to adjust to today s changing trade environment. The U.S. Foreign-Trade Zones program was created by the Foreign-Trade Zones Act of The Foreign-Trade Zones Act was one of two key pieces of legislation passed in 1934 in an attempt to mitigate some of the destructive effects of the Smoot-Hawley Tariffs, which had been imposed in The Foreign-Trade Zones Act was created to "expedite and encourage foreign commerce" in the United States. The means by which this is accomplished is through the designation of geographical areas, in or adjacent to Customs Ports of Entry, in which commercial merchandise receives the same Customs treatment as if it were outside the commerce of the United States. Merchandise of every description may be held in the Zone without being subject to Customs duties and other ad valorem taxes. While in a Zone, merchandise may be stored, repackaged, repaired, manipulated, used in manufacturing or processing, or even destroyed, free of tariffs and ad valorem taxes as long as the merchandise is in the Zone. This tariff and tax relief is designed to lower the costs of U.S.-based operations engaged in international trade, and thereby create and retain the employment and capital investment opportunities that result from those operations. These special geographic areas, Foreign-Trade Zones, are established "in or adjacent to" U.S. Ports of Entry and are under the supervision of the U.S. Customs Service. Since 1986, U.S. Customs' oversight of FTZ operations has been conducted on an audit-inspection basis, whereby Customs personnel assure compliance through audits and spot checks under a performance bond, rather than through on-site supervision. Today, the trade policy of the United States is based on a free trade model. This theoretical model recognizes only the economic beneficiaries of free trade; it acknowledges that the costs (or losers) resulting from free trade are negligible. In reality, however, free trade has benefits and costs. No doubt, the benefits far outweigh the costs; however, the costs are very

2 real. The Foreign-Trade Zones program offers a way to mitigate the costs of free trade. In doing so, the program allows the United States economy to enjoy relatively greater benefits from its free trade initiatives. The various benefits offered by the Foreign-Trade Zones program make it an effective response to the problems that arise when the $10 trillion dollar U.S. economy operates within the rapidly changing international trade environment. Benefits Offered by the Foreign-Trade Zone Program The Zones program offers substantial benefits to manufacturers and distributors in the United States. There are a few key benefits that attract most companies to the Zones program. Relief from Inverted Tariffs In certain instances, imported components used to produce a finished product are dutiable at higher tariff rates than the tariff rate that applies to the finished product itself. These inverted tariff relationships actually penalize companies that manufacture their products in the United States. They provide a lower effective duty rate for finished products manufactured overseas and imported into the U.S. market. The Foreign-Trade Zones program levels the playing field in these circumstances by allowing the Zone user to pay the lower finished product rate on foreign components incorporated into a product manufactured for domestic consumption. FOR EXAMPLE: A Foreign-Trade Zone user imports a motor (which carries a 4% duty rate) and uses it in the manufacture of a vacuum cleaner (which is duty-free). When the vacuum cleaner leaves the FTZ and enters the commerce of the U.S., the duty rate on the motor drops from the 4% motor rate to the free vacuum cleaner rate. By participating in the Zones program, the vacuum cleaner manufacturer has eliminated duty on this component, thereby reducing the component cost by 4%. Duty exemption on re-exports When not utilizing a Zone, an importer is required to pay Custom duties at the time the imported merchandise enters U.S. commerce. Merchandise in a Foreign-Trade Zone is considered to be outside the commerce of the United States and the U.S. Customs territory. When foreign merchandise is brought into a Foreign-Trade Zone, no Customs duty is owed while the merchandise remains in the Zone. If the foreign merchandise is exported from the U.S., no Customs duty is ever due.

3 Improved Logistics Two Zone procedures can be used in concert to improve an operation s logistics. The Direct Delivery procedure allows foreign merchandise to be transported in-bond directly to the Zone user s facility without clearing Customs at the first port of unlading, and without the necessity of the in-bond carrier reporting to the local Customs office prior to the delivery of the merchandise to the Zone site. Direct delivery procedures often save one to two days in delivery of foreign merchandise to the Zone user. This shortens the Zone user s international pipeline, thereby eliminating inventory within that pipeline. Since the formal Customs entry takes place when merchandise leaves the Zone for domestic commerce, Zone users often use the so-called Weekly Entry procedure to streamline shipments and Customs paperwork. Under the Weekly Entry procedure the Zone user files one Customs Entry per week, rather than filing one Customs Entry per shipment. This allows the Zone user to serve the domestic market without paperwork delays. Pursuant to the provisions of the Trade Development Act of 2000, the Weekly Entry procedure has been made available to all kinds of FTZ operations, including manufacturing and distribution operations. The FTZ Weekly Entry procedure often provides significant benefits to both the Zone user and the U.S. government. For Zone users operating in today s Just-In-Time environment, use of the FTZ Weekly Entry procedure means that hundreds, or even thousands, of import receipts over the course of a year are entered into the domestic commerce on only 52 Customs entries per year. In addition to saving the Zone user lots of paperwork, the company can reduce its payments of so-called Merchandise Processing Fees that are associated with the filing of a Customs Entry 1. The U.S. government saves by the corresponding reduction in the number of entry filings and the reduction of the costs associated with processing each Customs Entry. 1 The Merchandise Processing Fee is a user fee that is associated with the filing of a formal Customs entry. The Merchandise Processing Fee (MPF) is based on.21% of the value of the merchandise covered by a single entry, with a minimum of $25 and a maximum of $485 per Customs entry. As an example of MPF savings afforded by the FTZ Weekly Entry procedure, an importer who does not use the FTZ program and who receives 20 imported shipments (and files 20 Customs entries) per week, might pay as much as $9,700 each week in MPF. The same importer using the FTZ Weekly Entry procedure would pay $485 per week as shipments leave its FTZ facility, resulting in weekly savings of $9,215 and annual savings of $479,180.

4 Cash Flow (Duty Deferral) No duty payment is required on merchandise brought into a Foreign-Trade Zone unless and until the goods are imported (entered) into the United States. This allows these funds to be used as working capital to earn interest or be invested. No Duty on Value Added No duty is assessed on domestic parts or materials, OR on domestic labor, overhead, or profit. Quota Items No quota is applied to foreign goods in a Foreign-Trade Zone. Therefore, Zone users may take advantage of bulk shipments and store quota items in a Zone until the next quota period opens. This allows the Zone user to defer duty payment until the goods are actually imported, and gives the Zone user the advantage of being one of the first in the market when the quota opens. Zone-To-Zone Transfers A vendor located at one Foreign-Trade Zone may sell goods to a company in another Zone or Subzone anywhere in the U.S. and transfer those goods to the purchasing company s FTZ with no duty paid on the goods. Damaged or Nonconforming Items No duty payment is required if merchandise is not entered into the United States. If merchandise is defective or damaged, no duty payment is owed while it is being tested, repaired, or stored in the FTZ. (The actual importation does not occur until merchandise leaves the Zone and enters the commerce of the United States). Merchandise may be altered, repackaged, and/or relabeled to meet various U.S. requirements. Zones are often used for the purpose of properly marking the Country of Origin on goods prior to their entry into the United States.

5 Government and Military Sales In many cases sales of foreign merchandise may be entered into the United States duty-free if the vendor has a government contract in place. Foreign Trade Zone Environments There are two types of Foreign-Trade Zone environments, General Purpose Zones and Subzones. Both Zone environments can be used for manufacturing, processing and distribution. General Purpose Zones are established for use by multiple users, while Subzones are established for one user when its activity cannot be supported within the existing General Purpose Zone. A Zone project may have more than one General Purpose Zone site, even if the sites are not contiguous. Many Zone projects have more than one Subzone. General Purpose Zones A General Purpose Zone is a Foreign-Trade Zone site that may accommodate the operation of any number of firms, confined only by the physical limitations of the space in the Zone. Foreign and domestic goods may be admitted to the Zone for use in a variety of operations. These include storage, repackaging, repair, manipulation, destruction, and with Foreign- Trade Zones Board approval, manufacturing and processing. Customs duties and excise taxes are applicable only at the time goods leave the Zone for U.S. consumption. Subzones A Subzone is a single firm site designated for a special purpose under Zone procedures, typically manufacturing. Subzone users utilize the Foreign-Trade Zones program to reduce their operational costs associated with Customs duty. Subzone status may be granted if the business operation cannot be accommodated within the existing General Purpose Zone of the Zone project serving the area and if Zone status for the firm will result in a significant public benefit. An application to establish a Subzone must be submitted to the Foreign-Trade Zones Board in the same manner as a General Purpose Zone application. Approval of Subzone status is dependent upon the specific operations to be conducted under Zone status. The applicant must demonstrate that the Subzone status for the specific business operation will result in a significant economic benefit for the U.S. economy.

6 Growth and Use of the U.S. Foreign-Trade Zones program The U.S. Foreign-Trade Zones program has grown phenomenally over the last 25 years. In the early 1970 s there were fewer than 20 General Purpose Zones and Subzones in the United States. Today, there are more than 250 Zone projects, each with its own General Purpose Zone, and approximately 400 Subzones in the United States. Major industries that use the Foreign-Trade Zones program include the automotive, chemical, electronic, oil refining, shipbuilding, and pharmaceutical industries. Given that U.S. tariff rates have fallen significantly over the past 25 years, this tremendous growth might at first glance seem puzzling. However, falling U.S. tariff rates have actually spurred the need for Foreign-Trade Zone use. As round after round of multilateral trade agreements have lowered U.S. tariffs, U.S.-based manufacturers have often found themselves competing with overseas counterparts who enjoy low duty rates when their finished products enter the U.S. commerce. On occasion, as cited above, the U.S-based manufacturer must pay a higher duty rate on its imported components than the rate that applies to its finished product; that is, the duty rate relationship between its finished product and the components incorporated into the finished product are inverted. These inverted tariff rates are sometimes characteristic of across-the-board tariff cuts that result from multilateral trade agreements. There are only two means of obtaining relief from inverted tariffs: move the manufacturing operation offshore, or, alternatively, use the U.S. Foreign-Trade Zones program. Another outcome of falling tariff rates is the expansion of international trade. This too, has spurred the growth of the Foreign-Trade Zones program. As trade expands, the number of companies engaged in trade increases. Along with these increases there is an increase in the number of instances where the problems and challenges associated with a changing and expanding trade environment become apparent. For an increasing number of U.S.-based manufacturing and distribution operations, the most logical and efficient tool to fix the problems they encounter in today s competitive trade environment is the U.S. Foreign-Trade Zones program.

7 Another factor in the growth of the Foreign-Trade Zones program is community involvement. Each Zone project, including all of its Subzones, is sponsored by a local organization that has received a grant of authority to establish and operate a Zone project. Zone Grantees, usually local public entities, recognize the importance of the Foreign-Trade Zones program in helping existing industry remain competitive, and in the recruitment of new industry. Local Zones Grantees, by helping existing and prospective businesses understand and utilize the U.S. Foreign-Trade Zones program, have helped their communities and the nation enjoy the benefits of the U.S.-based economic activity that the program is designed to encourage. Copyright 2002 by Greg Jones