First Sale Rule: Reducing duties to import to the U.S.

The First Sale Rule allows the duty for imports of products into the United States to be calculated not on the purchase price from the middleman but on the price the middleman paid to the producer of the goods to be exported to the United States

ExportUSA customs counseling for importing goods to the United States through proper customs planning. Importing into the U.S. by taking advantage of the duty advantage offered by the First Sale Rule could be a good solution for companies with production in China.

The trade war between China and the U.S. continues, and the increase in import duties in the U.S. has increased costs for many companies with production in China that must import into the U.S. The problem also touches all those Italian companies that have production in China to export to the U.S.

The consequence is that many companies are considering restructuring their production chains, but the deep level of supply chain integration in China, the high cost of reconfiguration, and the strict standards of rules of origin in the United States complicate and lengthen such efforts.

A recent South China Morning Post report dusted off a system to reduce the impact of U.S. duties. The secret lies in the customs rule in place for the past 30 years in the United States called the "First Sale Rule".

First Sale Rule: a procedure for calculating goods to be imported to the U.S.

This is a process of calculating the customs value of goods, applicable whenever a product has been the subject of chain sales before its final import into the U.S.

Since the price of the first sale is naturally lower than that of any subsequent resale of the products, this method allows traders to realize significant savings, as ad valorem duties are calculated on a lower tax base.

The First Sale Rule is a customs strategy for exporting to the U.S. that can also be practiced by all those companies that import products made in China and wish to reduce the impact on duties

The procedure of importing into the U.S. through the First Sale Rule: a practical example of calculating U.S. duties

The First Sale Rule applies to the Importer of Record (IOR), that is, the person who primarily assumes the burdens related to the customs clearance of the goods and who, in addition to taking responsibility for the payment of duties and other administrative charges, must submit to the U.S. Customs the documentation necessary to clear the goods through customs. The Importer of Record typically imports goods into the United States through a model of multi-level transaction ["Tier"], in which the product is bought and sold several times before its final import into the U.S.

• Suppose a Chinese (or other country) manufacturer produces and sells goods for $10,000,000 to a European firm outside the U.S.
• In turn, this firm resells these products to an importer in the United States at a total price of $12,000,000, thus making a 20 percent profit.
• Suppose then that the duty to import this class of products into America is 9%.

By taking advantage of the First Sale Rule and using the original production price of $10,000,000 instead of the last price of $12,000,000 as the basis for duty calculation, the importer will pay a duty of $900,000 instead of $1,080,000 with a duty saving of $180,000 on duties to import into America.

How to get maximum duty savings for exporting to the U.S.

Usually, U.S. importers use the First Sale import technique when importing products with high import duties or when the margins charged by intermediaries are particularly high.

Another way to save further is to restructure the supply chain. U.S. Customs and Border Protection (CBP) allows certain expenses unrelated to the production of products (and therefore not subject to duty) to be transferred from the manufacturer to the relevant intermediary. As a result, the first price could be reduced without affecting the last pre-import price. Typically, we are talking about shipping costs.

Conditions for the applicability of the First Sale Rule

The First Sale Rule offers significant savings on calculating U.S. import duties. However, few companies adopt this duty calculation technique because the legal requirements, complicated documentation required, and practical problems can be daunting.

The transaction requirements for products to be exported to the U.S.

First, the multi-level transaction must meet the following general requirements from U.S. Customs:

• Bona fide sale: the first transaction between the manufacturer and the intermediary must be a bona fide sale, complete with a transfer of ownership.
• Transaction at arm's length: the Chinese manufacturer and the European exporter must be independent or, if related, must conduct their transactions at arm's length.
• Intended for export to the United States: from the time of the "first sale," the goods must be designed for export to the United States. For example, the goods are shipped directly from the supplier to the United States, or the goods are specially designed or labeled according to U.S. market standards or the requirements of the U.S. importer.

The documentation needed to calculate duties under the First Sale Rule

Second, to prove that the initial "first sale" price is accurate, the manufacturer, intermediary, and U.S. buyer must be able to submit the following documents:

• purchase orders with copies of terms between all parties;
• bill of sale;
• invoices;
• written contracts or sales agreements;
• products and materials bills of lading;
• evidence of payment (e.g., letters of credit);
• production orders and/or production instructions and other unique specifications of the goods to conform to the buyer's standards;
• examples of labels, logos, stock numbers, bar codes, and other distinctive merchandise marks;
• examples of country of origin marking on finished products, labels, etc.

Why don't many companies use the First Sale Rule to export to the U.S.?

There are several reasons why a high number of companies have not adopted the First Sale Rule, but the main reason is that companies must spend a significant amount of time and resources to ensure that a given transaction meets the compliance requirements of the First Sale Rule.

Since information with the requirements described above is often kept by different actors in the supply chain, it is necessary to develop challenging cooperative relationships and responsibilities between the manufacturer, intermediary, and importer.

Importers must convince other partners to "disclose" the first sale price and ensure that only the right people can see the documentation and sensitive data, which requires tight control over the process.

A growing number of companies are studying the applicability of the first-sale rule to offset increased costs resulting from the China-U.S. trade war.

Maxfield Brown, Business Intelligence Manager at Dezan Shira & Associates, said: "The application of the first sale rule is a smart tax optimization strategy for U.S. companies purchasing goods in international markets. If a Chinese good is sold through a Hong Kong wholesaler to a U.S. buyer, the good would still be subject to U.S. import tariffs set for China, but the value of the Chinese good on which taxes are calculated would be lower".

Although this strategy has obvious advantages, not all companies are suitable to use it. Hannah Feng, partner at Dezan Shira & Associates, says: "The first sale rule is subject to rigorous evaluation by U.S. Customs, so all companies cannot use this strategy. Companies that are seriously considering using the first sale rule should study carefully whether they are eligible; otherwise, they risk being turned away by U.S. Customs at a time like this when [U.S. Customs] is paying more attention to the application of the Rule."

In addition to legal eligibility, Brown also stated that the rule is unsuitable for all activities. "The ability of companies to take advantage of the first sale rule in the context of the U.S.-China trade war will depend on the presence and markup of wholesalers between a Chinese manufacturer and a U.S. buyer."

Although not a universal solution for all companies affected by the trade war, it can still be an effective tool for those whose model is applicable. "If the supply chain involves wholesalers and the First Sale Rule is not already being used, there is excellent room for maneuver to reduce the impact of U.S. import duties."

With companies on both sides of the Pacific impacted by U.S.–China tariffs, affected companies are ready to explore solutions to minimize their import costs. In this regard, the first sale rule could be an effective option for companies to reduce the impact of U.S. duties without significantly altering pre-existing supply chains.