China Customs 2003: Tensions and Progress

In early 2003, the United States Trade Representative¡¯s (USTR) annual report on foreign trade barriers publicized the continuing difficulties encountered by many importers of goods into China. The China section of the report summarized problems including the continued use of minimum or reference price lists rather than contract transaction value, and an overly broad inclusion of royalties into the value of imported goods, which will be discussed below. In addition, the report highlighted the prevalence of vague and inconsistent goods classifications, and barriers to the enjoyment of duty preferences for products covered by the Information Technology Agreement (recently entered into by China).

Meanwhile, the CA pursued a major enforcement effort that, in the first half of 2003, increased its collections through valuation adjustments by 124.97%, and its collections through classification adjustments by 136.82%.¹ 2003 also saw more anti-dumping investigations initiated than ever before under China¡¯s relatively new anti-dumping law.

Part of the CA¡¯s enforcement effort entailed an aggressive review of transactions where the CA suspected that low prices for imported goods, and a shifting of value from imported goods to royalty payments, might have occurred due to close relationships among various companies participating in complex supply chains. The Customs Valuation Agreement permits the CA to include royalties in the valuation of goods for purposes of calculating import duty and VAT, but only if the royalties are related to, and are also a condition of sale of, the imported goods.² The CA in early 2003 informally appeared to take the position that, if high royalties were related to low-value imported goods, and if the goods and the royalties appeared to be between companies involved in related supply chains, then the CA could simply infer, without detailed analysis or complete investigation, that all legal requirements were satisfied, and that the royalties should be included in the value of the goods. Importers, US exporters and US government representatives all raised objections to the CA¡¯s position on this issue.

Improvements at Year-end

In late 2003 the CA indicated informally that it was moving to a less aggressive policy on the inclusion of royalties in the value of goods, and there was a flurry of gap-filling customs legislation. General regulations on import and export tariffs were updated, and narrower legislation was issued on customs declaration procedures, on determination of Hong Kong origin under the Closer Economic Partnership Arrangement, and on customs remedies against import or export of goods that infringe intellectual property rights. This legislation is summarized below in order of issuance date.

Declaration procedures have been made clearer by the Administration of Declaration of Imported and Exported Goods Regulations (the Declaration Regulations).³ The Declaration Regulations contain much detail on the use of electronic filing procedures,⁴ which are clearly being encouraged, and contemplate further rules to facilitate the use of "real-time" declarations through computer link-ups.⁵ The Declaration Regulations also include considerable detail on the role of declaration agents, including an emphatic statement that liability will be borne by declaration agent individuals and companies.⁶ This will further encourage importers to engage agents rather than to handle filing on their own. The Declaration Regulations are flexible in spots, e.g., on the use of computer printouts in place of pre-printed forms,⁷ advance filing of declarations before arrival of goods at port⁸ and the use of a temporary price if the actual price will be determined after importation.⁹ Less satisfactory provisions include the one-year limit on availability of replacement documents, in the event that original documents have been lost or damaged.¹⁰

The most broadly applicable customs legislation of 2003 was the State Council, PRC Import and Export Customs Duty Regulations (the New Duty Regulations).¹¹ Prior regulations of the same name had been in place since 1992 and in many areas were inconsistent with newer developments in law and practice. The New Duty Regulations cover, in a general manner, most aspects of import and export duties. The New Duty Regulations also contain a reminder that special high duty rates will be imposed not only in cases of dumping, but also in cases of improper subsidies, in cases where market disruption merits safeguards,¹² and/or in cases where another country¡¯s breach of WTO rules entitles China to take retaliatory measures.¹³ The New Duty Regulations generally impose a one-year limit on applications by importers for post-assessment adjustments.

Intellectual property rights protection has been expanded by the PRC Customs Protection of Intellectual Property Rights Regulations (the IP Protection Regulations),¹⁴ which replace 1995 regulations covering the same issue. The IP Protection Regulations will facilitate IP owners¡¯ applications for detention by the CA, at the port of entry or exit, of goods that infringe intellectual property rights, including trademarks, copyrights, copyright-related rights and patents. An applicant must provide proof of ownership of intellectual property rights, and submit a security deposit with a value equivalent to that of the goods to be detained.¹⁵

Qualification of goods for mainland China import duty exemption and other preferences under the Mainland-Hong Kong Closer Economic Partnership Arrangement, is defined by the Customs Implementation of the under the Provisions.¹⁶ These provisions define "Hong Kong origin" goods as being either "entirely obtained" or "substantially processed" in Hong Kong. The regulations set out 10 examples of goods qualifying as "entirely obtained"¹⁷ and a relatively detailed discussion of activities qualifying as "substantial processing",¹⁸ but some related questions will require further interpretation.

Continuing difficulties

Before appealing a duty payment order, an importer must first pay the amount ordered.¹⁹ This precondition, although permitted by the Customs Valuation Agreement,²⁰ can effectively prevent an appeal by an importer that does not have the financial ability to make a large payment.

This risk makes it particularly important that importers have the opportunity to challenge any mistaken information or analysis on the part of the CA before the CA issues a duty payment order. The CA is required to provide a substantive written explanation of the reasons underlying any decision to disregard the contracted transaction value.²¹ For example, a finding that a non-arms¡¯ length relationship between the importer and the foreign seller influenced the goods price must include the reasons for that finding.²² Unfortunately, the CA in 2003 was sometimes reluctant to provide the required advance written explanation, making it very difficult for importers to rebut the CA¡¯s preliminary findings. Until the CA routinely provides timely and substantive written explanations, importers will need to protect themselves by giving prompt, careful and comprehensive responses to all CA inquiries.

Patience Needed

The absence of written explanations appears to have resulted from the fact that many of the new legal standards, and the way in which foreign supply chains value their products, were still unfamiliar to CA officials.

Patience was needed in 2003 on the part of foreign exporters and the USTR as the CA took time to improve its understanding and implementation of standards defined in the Customs Valuation Agreement. In 2004, patience will be needed from the CA, as it is forced to reconcile its obligations under the WTO with its revenue goals and its apparent suspicion of low-priced goods handled by complex supply chains.

Proactive Precautions

China¡¯s importers, and their foreign suppliers and investors, should consider proactive precautions. Internal audits and reform of cross-border supply chains can pre-empt most of the risks discussed above and, more generally, can improve tax planning. For many companies, questions that were asked and answered under China¡¯s old customs regime may need to be re-examined as China¡¯s transition to WTO harmonization increases both trading opportunities and potential risks.

Endnotes

1 Both figures compare the first half of 2003 with the first half of 2002, as reported (unofficially) on Chinese websites.

2 The 1994 Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade (commonly referred to as the Customs Valuation Agreement), Article 8.1.(c).