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LOGISTICS
From Site Selection magazine, September 2010
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Legal Fiction,
True Savings

Has your company paid heed to the potential benefits foreign
trade zone status can confer? If not, listen up.

LOGISTICS
Famous Footwear recently opened its dedicated West Coast Distribution Center at Tejon Industrial Complex in Bakersfield, Calif., within 177 acres (71.6 hectares)that were designated a Foreign Trade Zone in March 2009.
Photo courtesy of Tejon Industrial Complex

by MARK K. NEVILLE, JR.
S

ite selection is a complex and challenging process and the last thing that any company engaged in a site selection process welcomes is a further complication. Having to factor in any additional factor onto an already crowded “to do” list that will include such considerations as transportation or logistics network, proximity to vendors or customers, availability of adequate physical plant, human resources assets in the form of a skilled or trained work force or tax burden is sure to challenge most organizations.

Yet that is what this article is setting out to do. What I am suggesting is that the availability of legal status as a foreign trade zone (FTZ) for a potential site should have a major impact on many companies’ site selection process.

The starting point in evaluating whether an FTZ makes sense is whether or not the company is an importer and whether or not the site is meant to be used for storing or handling imported products. The benefits of an FTZ will apply whether the company is importing finished products and looking to a site so as to distribute and sell them or the company is looking at a site to be a manufacturing location as it is importing parts or raw materials to be further processed in the United States.

FTZ as Legal Fiction
Here is how it works:
1. To the extent that a company will be relying on a supply chain with one end located in a foreign country, that company will be dealing in goods that are imported into the United States.

2. When those imported goods cross the U.S. border, they are subjected to the full range of customs formalities and compliance obligations and, for most goods, the assessment of customs duties and associated user fees.

3. A foreign trade zone is a legal fiction deemed to be outside the customs territory of the United States. Various benefits will follow from FTZ status.

General Purpose Zone
and Subzone Status
There are basically two types of FTZs. General purpose zones are ordinarily at or contiguous to ports of entry and are typically run by governmental or quasi-governmental bodies such as a port authority, economic development authority or a city or country government. Subzones are those FTZ sites that are effectively satellites, sponsored by a general purpose zone and are run by or for the benefit of a single company.

Think of the two as a public warehouse (GPZ) and a private warehouse (subzone). One measure of the great flexibility of an FTZ is that a company need not relocate its facility to the general purpose zone; instead, the FTZ status can be conferred on an existing or a greenfield site.

All of this should lead to the question, “Do I care whether there is an existing general purpose zone that could either accommodate my operation within its existing site or sponsor an application for my company to obtain subzone status?” In other words, “Does an FTZ offer me any benefits?”

Benefits of FTZ
If imported goods are admitted into an FTZ, they have not yet entered the customs territory. Consequently, no customs duties or merchandise processing fees, which are collected on a per-entry basis, are due on the goods placed directly into an FTZ. In fact, those duties and fees are not due unless and until the goods are entered into the customs territory.

Duty Deferral: The most basic benefit is duty deferral. This duty deferral translates into a cash flow opportunity for the importing company, the variable metrics being the underlying value of the goods, the applicable duty rates and the time-in-inventory.

Duty Elimination:
For those goods that are re-exported directly from the FTZ, no U.S. duties are ever collected because they never enter the customs territory. This duty elimination on re-exported goods is a far better benefit than one derived from a duty drawback program, in which the importer would first enter the goods, pay duty up front and then wait until after re-exportation to put in a claim for a drawback refund of the previously paid duties. Aside from the obvious negative cash flow, Customs and Border Protection procedures demand a strict audit trail to prove to their satisfaction that any duty drawback claim is meritorious.

The ability to eliminate duty on imported products was a key factor in Yankee Candle’s application for FTZ status for its facilities in the Pioneer Valley of western Massachusetts, accounting for some 56 percent of its anticipated savings. Yankee Candle was granted subzone status in July 2010 and this was expected to double its export volume within four years.

Weekly Entry
For retailers and other high volume importers, another potential benefit lies in the ability to shrink the number of customs entries. For almost 10 years, importers have been able to make a weekly entry from an FTZ even if the goods were only stored and not further manufactured.

Prior to that time, the weekly entry protocol was available only in intra-FTZ manufacturing operations. While the FTZ user will be able to move as much of its product out of the FTZ as is necessary, the user would make one entry to cover all of the movements. Conceivably that could lead to a total of 52 entries for the year.

Since a high volume importer with, say, 10,000 entries a year would be paying a merchandise processing fee (MPF) on each entry, the use of an FTZ could dramatically shrink the number of entries and the corresponding MPF payments. Prior to 2005, most textile and apparel imports into the U.S. were subjected to a strict quota regime. Because quotas were applied by Customs at entry, importers of textile or apparel products who placed their goods into an FTZ ran the risk that the quota might be filled when they went to withdraw the goods for entry. For that reason, most of these importers elected not to make use of an FTZ.

With the elimination of quotas, it is a new ball game. In June 2010, the major retailer Abercrombie & Fitch was granted approval for FTZ status for its warehousing and distribution facility in New Albany, Ohio. A&F’s overall savings on its imports of apparel and related accessories on a five-year basis were estimated to be just shy of $17 million.

While A&F did not break out the savings associated with weekly entry in its application, other retailers have done so. One of these is VF Corporation, which foresaw $650,000 in annual savings at its Martinsville, Va., site, 55 percent coming from weekly entry and a further 44 percent from duty deferral. Another was Swatch Group. In its 2009 application for a warehouse/DC subzone, Swatch estimated that the weekly entry savings — lower customs broker charges, MPF, paperwork —were expected to account for 70 percent to 75 percent of total savings.

Swatch pointed out that a number of its competitors in the watch and jewelry industry have FTZ status for some of their facilities. These include Fossil, Movado, Bulova, Tiffany, Zale, Citizen and Richemont. FTZ status appears to have become an industry standard.

Inverse Tariff
One of the primary benefits associated with FTZ is that of the “inverse tariff” principle, which refers to the difference in duty rate associated with an imported part or raw material and the finished product. The inverse tariff principle might be seen at work where an importer is going to manufacture a finished product that caries a zero duty rate if it had imported the finished product.

Let’s call the finished product a candle. Now, let’s assume that the candle maker will want to import metal lids in making the candles, and pays a duty of 2.6 percent on the imported lids. By declaring a “non-privileged foreign status” on the lids when they are admitted in the FTZ, and manufacturing the finished candles under a grant of manufacturing authority, the duty will be levied on the value represented by the lid at the duty rate that applies to the finished candle. This happens to be zero. By manufacturing in the FTZ and using the inverted tariff opportunity, the importer has stepped down the duty rate from 2.6 percent to zero. As you might have already guessed, this is precisely what Yankee Candle is doing with its FTZ operation, with this planning opportunity responsible for an estimated 20 percent of the savings associated with the FTZ.

It is this inverted tariff which is the driving force for most of the auto assembly plants as well as other manufacturing or assembly sites being situated in sites with FTZ status. Recent auto plant FTZ application activity is represented by the grant to Kia for its West Point, Ga., location and Volkswagen’s still-pending application for its facility in Chattanooga, Tenn. In its 2008 application for manufacturing authority to build barges and other vessels at its FTZ site, the Tampa Bay Shipbuilding and Repair Company predicted that the inverted tariff would account for a full 95 percent of all savings traceable to its FTZ status.

For customs purposes, manufacturing does not need to be as full bore as an auto plant, and the descriptor will apply to an assembly or “kitting” operation as well. Thus, the assembly of foreign liquors, glasses and other items into gift sets by Bacardi at its Jacksonville, Fla., location required manufacturing authority from the Foreign Trade Zones Board. The kitting activity gave rise to an inverse tariff savings opportunity.

State and Local
Tax Benefits
Apart from these savings associated with customs duties, there are tax savings that also apply. The federal customs law on FTZs has created an exemption from state and local ad valorem property taxes on inventory for imported goods or for domestic goods bound for export that are stored in an FTZ. In states such as Arizona or Texas which rely on these taxes, an FTZ could throw off savings here as well. Better be careful to get local buy-in, however, as the FTZ application process requires a showing that the application is in the public interest, and any opposition from local taxing authorities is guaranteed to place an application at risk.

Evaluation and
Application Process
The first task for a high-performing company is to be aware of FTZs and their potential benefits. It may sound trite, but the biggest obstacle in making the best informed strategic decisions is a lack of information. If a company is looking for a site that will be used in connection with imported products, that company should be asking whether an FTZ makes sense for them. If an FTZ does make sense, then the company should next determine if the potential zone sites carry with them the potential for FTZ status. There are a dizzying number of general purpose zones scattered through the country and Puerto Rico, which is also within the customs territory. In the competition to attract investment, many state and local government authorities have employed FTZ status to help them win the game. At this time, applications for GPZs are pending for Bakersfield, Calif., and Maricopa County, Ariz.

Any of those general purpose zone sites could conceivably accommodate a company’s FTZ operation or sponsor the company’s own physical site as a subzone. The only caveat is that the subzone must be “adjacent” to the customs port of entry, which means within 60 miles (97 km.) or 90 minutes’ drive time of the outer limits of the port.

After analyzing the potential benefits, any application for a subzone is actually filed with the Foreign Trade Zones Board, an office with the U.S. Department of Commerce, by the general purpose zone on behalf of the company applicant. The hard work of preparing the application is typically done by the subzone, however. A key element in the process is a showing of community and political support for the project. It is prudent to garner that support at the earliest point, before a site selection decision has been taken, with the company making it clear that such support is an important factor in its decision.

The application process is highly formalized, with a prescribed list of information, economic justification and a demonstration that the public interest would be served by the subzone status. A notice is posted in the Federal Register, giving interested parties a chance to comment or object to the application. If approved, the subzone must be activated, which process is supervised by Customs and Border Protection (CBP). CBP is focused on cargo security, and a key element for them is a demonstrated inventory control system. The entire process can take up to 15 months or more, especially if manufacturing authority is sought.

An FTZ status can generate significant savings for a company that depends on a source of imported goods for its business success. It makes sense for the site selection process to include a review of the potential benefits of FTZ, and to add the availability of FTZ status to the other important considerations that already characterize that process.


MarkNevilleMark Neville is Counsel in the Corporate and International practices at Smith Gambrell & Russell. He has over 30 years experience in international trade and customs affairs, and has advised numerous U.S. and foreign-based companies on strategic matters of planning, compliance and enhanced efficiencies. He has served as a trial attorney with the U.S. Dept. of Justice representing the Customs Service and the Treasury Dept., and also founded and ran the U.S. trade and customs consulting practice at KPMG. He has served as an adjunct faculty member of the Walter A. Haas School of Business of the University of California, and at NYU’s Stern School. He may be reached at mneville@sgrlaw.com.



Story in Pictures

More than 250 Fedex employees will occupy 146,792 sq. ft. (13,637 sq. m.) at Ellington Trade Center in Houston beginning Oct. 1. Located across from Ellington Field, the site features three buildings totaling 513,800 sq. ft. (47,732 sq. m.). Ellington and another Texas site, Northpointe Trade Center in Austin, are part of an industrial development program launched in 2008 by KDC and Harbert Management Corp.
Photo courtesy of KDC
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