Customs

Ramping Up Customs Compliance Reviews

Companies must create strong compliance teams and comprehensive checklists to stay on the right side of the law

by Tony Kerr

During the past few years, little has been more bewildering, frustrating, and costly for companies than new government requirements for compliance in almost every area of business. In addition to requirements under the 2002 Sarbanes-Oxley Act, companies face new security, health, and quality requirements, some of which apply to the cross-border movement of goods.

Quick Glance

Companies should take a holistic approach to ensure full compliance with China's complex and changing customs requirements.
At minimum, companies involved in cross-border trade or manufacturing under bonded conditions should complete a full customs compliance review of their operations once a year.
They must also decide whether to set up an in-house customs compliance team or hire an external service provider to conduct reviews.

Customs compliance requirements have been affecting a growing number of businesses involved in the cross-border movement of goods and the manufacture of goods under bonded conditions. Free-trade agreements have also added customs requirements, because the agreements often contain provisions for the sharing and disclosure of companies' information with other customs authorities or for audits by teams from an importing country's customs service.

To ensure full compliance with complex and changing customs requirements, companies should take a holistic approach. Any company that uses a myopic or piecemeal approach is likely to overlook potentially serious problems in its business transactions that may be found during a customs audit. Having a sound, efficient, and effective customs compliance review program in place will certainly pay dividends.

China's customs environment

Since China's World Trade Organization (WTO) entry in 2001, the PRC General Administration of Customs has made significant strides toward becoming a modern and transparent authority. Though the abilities of China's customs officials have improved enormously over the last decade, China's customs regime still faces many transparency issues and differences in interpretation among regional offices. As a result, companies must be fully aware of statutory and regulatory requirements from a cross-border perspective.

Changes that have affected the country's economic and industrial environment include the rapid development of free-trade zones, export-processing zones, bonded logistics parks and centers, and bonded harbors, all of which are supervised by Customs. Despite their advantages for companies and localities, these areas have introduced new difficulties that Customs officials have sought to resolve. For instance, authorities in local free-trade and bonded zones often provided incentives that pushed legal boundaries to entice investors to establish their business within a particular zone. Some practices allowed the storage of non-bonded goods within a bonded area or allowed major processing in areas that only legally permitted minor processing. In addition, some customs offices in these zones allowed transactions between related parties that did not comply with customs valuation rules under the WTO and PRC customs laws. This practice grew considerably until a few years ago, when Customs and the State Administration of Taxation realized how much revenue was being lost and how much noncompliance in these areas had grown.

Customs has begun slowly taking steps to correct these practices. For example, Customs is monitoring processing-trade enterprises better and is using independent third-party auditors to perform compliance audits. It has also introduced new laws to make it clearer to processing-trade enterprises that they must obtain Customs approval before moving goods to other manufacturers. With these changes, many companies that have benefited from noncompliant practices will find becoming fully compliant an expensive exercise.

The importance of customs compliance

Major noncompliance with customs requirements could bring a significant part of a business to a halt.

Companies should be aware that major noncompliance with customs requirements could bring a significant part of their business to a halt, especially if China is a key part of a company's supply chain and their China supply chain is noncompliant. The impact of noncompliance on a flourishing business cannot be underestimated, though the risks depend upon the severity of the noncompliance. For example, Customs can downgrade a company's customs status, resulting in clearance and approval delays. It can also inflict heavy penalties and collect revenue retroactively. For serious noncompliance, the legal representative of the China entity can face questioning, travel restrictions, or detainment pending the outcome of an investigation. Moreover, companies that fail to comply with PRC Customs and are publicly listed in the United States may face criminal charges in China and suffer the economic, legal, and reputational effects that such charges can have on a company and its board of directors.

Find compliance problems—and fix them

When China entered the WTO, it enticed foreign companies with its large, low-cost workforce and generally lower business costs. In their rush to enter China, however, many of these new investors failed to conduct the all-important planning, due diligence, risk assessment, and implementation of quality- and internal-control systems required for sound investment.

A key part of planning is conducting a risk assessment of a country's regulatory climate and, for import-export and manufacturing companies, an in-depth analysis of its customs regime and other border-agency requirements. Companies that do not conduct adequate risk management in their early ventures often face costly and complex customs problems as a result. And if they have a weak network of contacts and lack knowledge of customs requirements, they often experience lengthy delays and high costs when resolving customs problems. Some of the steps taken to resolve these matters can cause other noncompliance issues beyond customs. For example, new problems can arise if an individual within a company attempts to fix a problem on his or her own and inadvertently puts the company in breach of its obligations under the US Foreign Corrupt Practices Act (FCPA).

Today, China is more transparent and has new laws that more closely reflect the global trading environment. There are more avenues available to address concerns legitimately and a greater openness to discuss and resolve issues. In addition, several well-established business associations, such as the US-China Business Council (publisher of the CBR) and American Chamber of Commerce, provide useful information on regulatory changes and their potential impact on business and assist companies through a network of business and government contacts.

Yet even in this improved environment, some companies fail to establish customs compliance programs or conduct a complete and systematic compliance review that would allow them to identify and quantify any potential exposure. At minimum, every company involved in cross-border trade or manufacturing under bonded conditions should complete a full customs compliance review of each of their operations once a year (see Table). The review can be conducted by internal customs and trade specialists or by a third party.

Compliance teams—internal or external?

Each company must decide whether to set up an in-house customs compliance team or hire an external service provider to conduct its reviews. Most companies conclude that maintaining an in-house customs compliance team is the most cost-effective solution, even though its cost can be substantial.

To develop an effective internal customs team, companies must hire sufficient personnel with advanced customs and trade skills and give them the full support of all business units within the company and of all levels of management. The team must also have an adequate budget and resources for it to function effectively. In addition, it should have an excellent network of contacts in PRC and US customs and other government departments with whom team members can liaise to keep up-to-date on the latest legal changes that affect their industry. In a small- to medium-sized operation, a two-person team for each region should be enough, while a larger operation will need at least three to five people per country, depending on the number of entities the company has within that country.

An external service provider would have a team of customs and international trade experts that can normally function as a company's global service provider. Though costs would likely be higher for the first full compliance review, follow-up reviews during the course of a year should cost much less.

Whether a company uses an internal customs team or an external service provider, the team or service provider must follow the requirements of the US FCPA, PRC anticorruption laws, and similar legislation in discussions with PRC government authorities and local bodies. (China has not yet implemented a comprehensive anticorruption law, but government agencies have their own provisions relating to payments, entertainment, and gifts.) For US-based companies, it is important that all staff, including a company's internal customs team, are fully aware of FCPA provisions and PRC anticorruption legislation. Companies should also ensure that the consultancy or legal firm they have retained is fully conversant in these types of legislation and practices full compliance.

General customs requirements

Companies reviewing their customs compliance in China should initially think about three things: the valuation of their products, especially products traded between related entities; the classification of the product under the Harmonized System of tariff classification; and the origin of goods from a preferential tariff and a labeling perspective.

Companies should also review their compliance with other requirements that could affect Customs' clearance of their goods. Such requirements may include PRC Administration of Quality Supervision, Inspection, and Quarantine approvals; laws and regulations related to approved processing-trade entities (bonded manufacturing entities); laws and regulations related to entities in free-trade zones and other bonded areas or facilities; PRC export control regulations; foreign corrupt practices legislation or similar legislation; and record retention laws of Customs and SAT, as well as those under companies' business license approvals. Companies with ties to the United States must also comply with US export control laws.

Another important area for companies to check is the compliance of any third party that interfaces with Customs on their behalf. This should be a standard check when a company first hires its customs broker or similar third-party service provider and on a regular basis thereafter. The compliance review of a customs broker or agent should identify the processes that it uses to represent the client company at Customs. It should also confirm that the broker or agent classifies goods correctly under the Harmonized System and understands customs valuation well. To ensure that its interests are not compromised, a company should also investigate the relationships its service providers have with Customs and other government officials. In particular, companies should regularly check the accounts they receive to confirm that the fees being charged are in accordance with what they have negotiated. They should question any extra fees and ask for evidence to support the fee. In addition, companies should speak with their service providers' staff to understand how they interact with government officials—including whether they entertain officials or provide other services. A company should also investigate if it imports products it knows should have some restrictions or inspections, yet the goods arrive without delays or inspections.

Processing trade requirements

Entities that are approved by Customs to import raw materials without paying customs duty and value-added tax are known as either bonded manufacturers or Customs-approved processing-trade entities. Bryan Cave International Trade LLC has observed that many of these companies tend to have poor inventory controls in place on raw-material use and finished-goods production. It has also noted that processing-trade entities frequently move goods to other manufacturing entities when they have no further capacity to manufacture, often without Customs approval. Again, effective internal control procedures should be in place to ensure good inventory control and to ensure that appropriate approvals are sought.

Merger, acquisition, and joint venture requirements

Companies often overlook customs compliance verification when considering mergers, acquisitions, and joint ventures. When companies seek to acquire another company or to enter into a joint venture agreement, their auditors or legal representatives, either in-house or external, usually conduct legal and financial due diligence reviews of the target entity, but often fail to include full customs and trade due diligence. When the target entity is a trading or manufacturing entity that has been importing and exporting goods, the acquiring company can be held accountable for the target company's noncompliance if revenue authorities conduct an audit. (Though there is a limit on the pursuit of shareholders in these instances, Customs can claim revenue, impose penalties, and disrupt operations because of past offenses by the previous company.)

Don't miss your annual check-up

A regular compliance program is like a regular health exam—people need a yearly check-up, but they must decide whether to visit and pay for a family doctor or a team of specialists. Whether a company has in-house personnel to undertake this compliance function or hires external consultants is a business decision that should be based on getting the best professionals to do the work. The discussion above lists just a few of the areas in which noncompliance can occur. As China tightens customs enforcement, companies can only benefit from getting their own house in order and fully complying with the letter of the law.

Key Areas to Include in Customs Compliance Programs
Source: Bryan Cave International Trade LLC
Compliance area	Comments
Pre-shipment inspection and license requirements	These inspections and requirements particularly affect used and refurbished products, medical devices, pharmaceuticals, and agricultural and food products. Products that have been repaired and are being imported as "replenishment stock" for use in after-sales servicing are considered used and require pre-shipment approval for their import. Such products cannot be stored within bonded facilities in China.
Harmonized System of tariff classification	Incorrect classification affects duty rates, value-added tax rates, origin, labeling, permit requirements, license requirements, export controls, and import-export prohibitions and restrictions.
Customs value	Related parties are subject to valuation checks, and a transfer price that complies with Organization for Economic Cooperation and Development guidelines will not be accepted for customs purposes (see China's Special Tax Adjustment Regulations). If royalties, distribution fees, and franchise fees are applicable, they may be added into the value by PRC Customs.
Certificate of origin	Companies should ensure they have correct documentation that is fully certified by the approved issuing authority in the country of manufacture.
Customs licenses and approvals; business licenses	Companies should confirm that They comply with processing trade approvals and associated manuals; Their business complies with acquired approvals; and Their business licenses comply with the approved scope and any other requirements.
Entities in bonded locations	Companies should Monitor the bonded zone's customs requirements and comply with them; Confirm that controls on the movement of goods within and outside of a bonded facility are in place and effective; Comply fully with processing-trade export requirements (if a processing-trade entity), and obtain the appropriate approvals (if importing finished products); and Review security and inventory controls.
Customs brokers and logistics service providers	Companies must set controls to monitor the work that third parties do on their behalf. The acts performed by third parties regarding a company's goods are legally the acts of the principal.
Employees	Companies should ensure they have good job descriptions and training for staff. Companies should also be aware that disgruntled employees could divulge company information to authorities.
Foreign Corrupt Practices Act (FCPA) and similar legislation	Companies must provide good FCPA-related training and awareness programs to all employees and third-party service providers. They must also have effective controls on discussions with government authorities and any proposed entertainment of these authorities.
Export control legislation	Companies should classify their products correctly within US export control legislation to ensure they have the correct instructions for their products.
Document retention	PRC Customs, State Administration of Taxation, and business registration laws all require some form of document retention. Companies need to understand what each document is and in what format it can be retained.
Finance	Companies should record inward and outward revenue and ensure that the recording of payments made or received and their associated orders or purchase agreements are accurate, complete, and properly authorized.
Internal logistics	Companies should also verify that the actions that personnel in this area take comply fully with Customs and other cross-border requirements.

Tony Kerr is regional director, Customs and Trade, at Bryan Cave International Trade LLC; he is based in Shanghai.

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