Trade Compliance Healthcheck and Self-disclosure

By Deming Zhao


“In a recent report by customs and trade compliance practice of Global Law Office, out of the reported administrative investigations by ASB of Shanghai Customs in 2018, 39% cases were triggered by HS code inaccuracy that resulted in imposition of administrative penalties. This illustrates how easy the importer or exporter of record may incur liabilities for using wrong HS codes in China.” 


I. Significance of Trade Compliance


Under the integrated clearance reform, customs clearance efficiency is greatly increased. However, trade facilitation is based upon trade compliance on the part of all importers or exporters of record. On one hand, the company with good compliance records may be rewarded with an AEO status to enjoy more trade facilitation benefits; on the other hand, illegitimate declaration and customs clearance practices can be easily identified through monitoring systems of the Tax Collection Centers and Risk Control Centers, and through more vigorous post-clearance customs queries, audits and investigations. 


In the event of non-compliance with China customs law for import transactions, the importer of record for instance will be exposed to 30%-200% of short payment of import duties, VAT, and consumption tax (if any). If illegitimate declarations are intentional, the importer of record will be exposed to the administrative or even criminal smuggling liabilities. Those individual employees of the importer will be indicted with the crime of corporate smuggling if they directed or simply knew the incorrect declarations to China customs before or at the time of the declarations. For export transactions, non-compliance with China customs law by declaring incorrect HS code may result in over-claiming export VAT rebate benefits, or evading the export control regulations, and there may ensue a customs penalty or even the crime of export VAT rebate fraud or the crime of smuggling when the exporter of record knew or must have known that the declared HS code was not correct.


In serious cases, China customs may discredit the importer of record who will lose the trade facilitation treatment. 


For any non-compliance case, if the short payment of customs duties and VAT amounts to several thousands of RMB, Anti-smuggling Bureau (“ASB”) will investigate into the case. 


II. Trade Compliance through Healthcheck


Post-clearance audits by the customs authorities will trace three years of past import and export clearances. ASB will investigate and penalize illegal declarations that occurred within the prior two years. However, if illegal declarations are of a continuous nature or they are intentional mis-declarations, ASB of China customs will not confine its investigation to two year clearances retrospectively.


From manufacturing multinational companies’ perspectives, it is by no means an easy task to ensure trade compliance. Given the technical nature of items to be declared, such as tariff classification, customs valuation and country of origin, understandably there are often errors or mistakes in declaring such items relevant to thousands or even millions of part numbers. The risks of non-compliance would be out of control if there were no regular healthchecks or internal compliance audits on such trade declarations. 


Accordingly, the importer or exporter of record at least must ensure (a) if it has any non-compliance incidences in the recent two years and (b) such incidences can cease and be rectified as promptly as possible. The healthcheck or legal audit of import and export practices will help to ensure such trade compliance. 


1. HS codes


HS code is one of the key areas for trade compliance healthcheck as legal risks often arise from issues relating to mis-classification of import or export goods. In a recent report by customs and trade compliance practice of Global Law Office, out of the reported administrative investigations by ASB of Shanghai Customs in 2018, 39% cases were triggered by HS code inaccuracy that resulted in imposition of administrative penalties. This illustrates how easy the importer or exporter of record may incur liabilities for using wrong HS codes in China.


For an HS code used for a given import product, for instance, the importer of record must review the “declaration elements” China customs has assigned to that code, to see whether declaration elements that function in the classification rules of China nomenclature are consistent with the product itself. Assuming consistent, the importer of record has to reasonably exclude applicability of other HS codes to the same product. This is difficult as this is a matter of application of technical and complex classification rules to different products. In other words, this is a difficult and technical legal issue and preferably must be controlled by customs lawyers. 


China now uses 13-digit HS codes. Although the first 6-digit headings and sub-headings are universal in theory, China customs may identify headings or sub-headings different from a customs authority in another country. 7-8 digits as China subheading are subject to China subheading notes. 9-10 digits imply customs supervision mode (e.g. whether a license is required) and 11-13 digits reflects the supervision modes by AQSIQ which is now part of China Customs as a whole. 


Given the possible different practices in China, it should be considered to review all import HS codes used in the past no matter whether the first 6 digits are consistent with export HS codes of the exporting country. 


In case the company finds it difficult to determine a given HS code as a matter of law, the importer or exporter now may apply for a pre-ruling on HS code to China customs. The pre-ruling application shall be made when the existing classification rule is truly unclear. This is a new method promoted by the customs in 2018. The pre-ruling application shall be made when the existing classification rules and decisions are truly silent on the HS code of the same product. Careful assessment and communication with the customs authorities must be made before official application is submitted. In this connection, we helped a multinational client and obtained the first pre-ruling from Shanghai Customs.


Healthcheck on HS codes may avail the company to apply for the customs precedent HS code database status to be certified by China Customs. We are now helping a multinational client in reviewing HS code database with China Customs in a pilot program of customs precedent HS code database certification. 


2. Dutiable Value and Transfer Pricing


Customs valuation is the second reason for ASB investigation cases according to GLO reports on Shanghai Customs investigation cases.


(a)     Dutiable value elements


China customs will determine the dutiable value of import goods roughly on the basis of CIF value. If the import price does not include CIF elements, the importer of record must ensure the declared dutiable value has cost, freight and insurance ingredients. Failure to declare freight for FOB import transaction for instance will result in short payment of import duties which will be exposed to customs audit or ASB investigation. 


(b)     Undue transfer pricing fluctuations


As most imports are subject to inter-company transactions, the import price will be viewed by China tax and customs as transfer pricing. Due to system or human errors, the import or export price as declared sometimes does not reflect the true value of transfer pricing policy and would affect import duties or export VAT refund amount. Very likely the ASB will view such errors as untruthful declaration of import and export values and impose a customs penalty. Companies must carefully address such error cases in the process of healthcheck and sometimes legal defenses can be developed  to avoid customs penalties. 


(c)     Customs re-valuation 


For import transfer price, China customs may raise queries against the import transfer price at any time when customs authorities have reason to believe the import transfer price is affected by the inter-company relation between the importer and exporter of record. Such reason can be abrupt increase or decrease in the import price, or unreasonable stability of import price for two years or more. 


If the company cannot justify the adequacy of its price with customs valuation methods, customs will re-value import goods and thus increase the import dutiable value and levy more import taxes. 


The healthcheck will determine whether the import transfer pricing set by tax rules may also justify itself under custom valuation rules. Sometimes this involves design of business models to avoid or reduce customs valuation risks. 


(d)     Royalties


Royalties for licensing intellectual property to a subsidiary in China by a multinational company are often not included in import transfer price and thus China customs will levy import duties on such royalties if relating to import goods even though the licensee paid tax to tax bureau already. It is a complex issue and process for customs to determine the connection of import goods to royalties and if so how to apportion the amount of royalties to the dutiable value of the such import goods. Normally there is room for multinational companies to avoid or reduce such customs duty risks. 


A healthcheck will assess the dutiability risks of such royalties and determine whether legal defenses are available and whether the licensing model can be improved. 


III. Self-disclosure


Through the healthcheck, if any non-compliance is identified, the importer or exporter of record must cease such non-compliance immediately. For future declarations, the trader must make correct declarations or use reasonable customs values as suggested by the professionals conducting the healthcheck. 


For problems occurred in the past, the company may consider self-disclosure scheme to resolve all past issues. 


Self-disclosure policy is promoted by China Customs since 2016 to encourage self-exposure of non-compliance declarations by traders. If the self-exposure nature is accepted by a given customs, non-compliance will be subject to a penalty less than the statutory range. If the non-compliance is of a minor nature, corrected in a timely manner and has no harmful consequence, the customs would impose no administrative punishment. When the company makes up for the short-paid tariff, the customs may reduce or exempt late surcharge.


Please note, however, if it is a crime of smuggling, self-disclosure would not eliminate the criminal consequences, though the criminal penalty may be reduced as a result of self-disclosure. Therefore, thorough legal review of the whole case is crucial before the self-disclosure is submitted to the customs. 


IV. Conclusion


Given the vigorous post-clearance audits and investigations by China customs, the importer or exporter of record must have a regular trade compliance healthcheck in place to identify and eliminate illegal declarations or customs clearances in a prompt way. This will effectively prevent legal liability risks from accumulating, and resolve the issue before it escalates to a crisis. Self-disclosure is one of the ways to resolve the non-compliance issues. For both healthcheck and self-disclosure, legal advisors can accurately identify the non-compliance and risks and at the same time possibly develop defenses to protect the interest of both the company and its management. 


[Ms. Du Yiqi, associate of Global Law Office, also makes contribution to this article]


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