Foreign Trade Zones and Subzones
This Memorandum outlines briefly rules concerning the establishment and operation of Foreign Trade Zones (FTZs) and subzones in the United States. Many United States manufacturers are using FTZ and FTZ subzone status to reduce operating costs for United States manufacturing and inventory facilities.
FTZs: Purpose and Function
As authorized by the Foreign Trade Zones Act of 1935, as amended, 19 U.S.C. Section 81 et seq., Foreign Trade Zones (FTZs) are designated areas within the Customs territory of the United States which are treated for tariff purposes as though they were located outside the Customs territory. Foreign and domestic merchandise of all kinds may be brought into an FTZ without payment of duty for the purposes of storage, display, manipulation, sale (except retail sale) and manufacture into new and different articles. Where goods are withdrawn from an FTZ for exportation, no Customs duty consequences result.
Where goods are withdrawn from an FTZ for consumption in the United States, Customs duties are payable only at the time of withdrawal for consumption. As noted below, where goods are produced in an FTZ or subzone from imported materials, duties are assessed only on the value of the imported materials contained therein — and the importer may, by electing “privileged foreign” or “nonprivileged foreign” status for the imported materials, favorably influence the rate of duty paid. These concepts are explained in further detail below.
Thus, FTZs offer United States importers and manufacturers extraordinary flexibility in conducting manufacturing and international distribution operations.
Establishment of FTZs and Subzones
FTZs must be located in or adjacent to United States ports of entry. The interagency Foreign Trade Zones Board, comprised of representatives from the Departments of Commerce, Treasury and the Army, issues FTZ “grants” to municipal governments, port authorities and non-profit corporations to establish FTZs, which are known as “general purpose” FTZs. At present, 180 general purpose FTZs have been authorized by the Board, and are in operation. General purpose FTZ facilities may include warehousing, open storage areas, office and factory space, or simply land intended for future development.
In addition to general purpose FTZs, the Board is authorized to designate private storage or manufacturing facilities as FTZ “subzones”. Thus, for example, a company could apply to designate part or all of its United States manufacturing facilities as “subzones” of general purpose FTZs.
During the past two decades, the use of “subzone” status for United States manufacturing facilities has proliferated explosively. A decade ago, approximately $600 million worth of goods were produced annual in FTZ subzones: by 1990, annual FTZ manufacturing accounted for over $50 billion. Most United States auto assembly plants are operated as FTZ subzones, as are factories engaged in the production of chemicals, food products, consumer electronics, computer equipment, and a wide range of other goods.
General purpose FTZs are required by law to be operated as “public utilities”. FTZ grantees are required to advocate and promote the use of FTZs and subzones.
Tariff and Tax Benefits of FTZ Manufacturing
1. Tariff Benefits:
Many companies manufacture their goods in FTZ subzones in order to obtain the benefit of deferred duty payments and “inverted” tariff rates. As noted above, duty payments on imported goods are deferred until the goods, or products made therefrom, are withdrawn from the FTZ for United States consumption. Duties can be avoided altogether on goods withdrawn from the FTZ for exportation (making it unnecessary to maintain manufacturing or same-condition drawback programs).
FTZ procedures allow manufacturers great flexibility in determining the duty rates which will be applied to their products. FTZ and subzone manufacturers have the right to make an election concerning how goods which they import into an FTZ should be treated for tariff purposes: (1) They may elect “privileged foreign” status for the merchandise. This locks in the product’s duty rate according to its condition at the time it is admitted into the FTZ; or (2) They may elect “nonprivileged foreign” status for the merchandise. This will subject the goods to duty according to their condition and applicable duty rates at the time the goods (or merchandise made therefrom) is withdrawn from the FTZ for consumption in the United States.
Some examples may help to illustrate these principles, as follows:
A. “Nonprivileged Foreign” Status
As noted above, nonprivileged foreign status allows the duty rate applicable to an product entered into an FTZ to “float”, and be determined according to the condition of the merchandise, and duty rates in effect, when the imported product (or a product manufactured therefrom) is withdrawn from the FTZ for consumption.
Example 1. In December, 1992, Acme Company enters a chemical valued at $10,000 into an FTZ subzone with “nonprivileged foreign” status. If the chemical were imported for consumption in December, 1992, it would be dutiable at a rate of 20% ad valorem, for a duty payment of $2,000.
Acme withdraws the chemical, unchanged in condition, from the FTZ for consumption, in February, 1993. At this time, assume that the rate of duty for the chemical has been reduced to 18% ad valorem [e.g., pursuant to a "Uruguay Round" tariff reduction]. Acme would pay duty on the chemical at the 18% ad valorem rate, for a total duty payment of $1,800, and a duty savings of $200.
Similar benefits are available when manufacturing operations are conducted in an FTZ subzone:
Example 2: Assume that Acme Corporation manufactures bulk photographic chemicals at an FTZ subzone factory, using materials of domestic and foreign origin. The chemical, if imported directly into the United States, would be subject to duty at a rate of 8.5% ad valorem. Assume further that Acme manufactures the photographic chemical using $10,000 worth of foreign-made nigrosine dye which, if imported directly, would be dutiable at a rate of 20% ad valorem, resulting in a duty payment of $2000.
Acme would elect “nonprivileged foreign” status for the nigrosine dye when entering it into the FTZ. When the finished bulk photographic chemical is withdrawn from the FTZ for consumption, Acme would pay duty on the value of the nigrosine dye at the 8.5% ad valorem duty applicable to the finished chemical, i.e., $10,000 x 8.5% = $850, for a duty savings of $1150.
Please note that no duties are assessed in respect of any value added by manufacturing in the FTZ. Rather, duties are assessed on the dutiable “transaction value” of imported components at the time they enter the FTZ.
B. “Privileged Foreign” Status
“Privileged foreign” status “locks in the rate of duty at the time and condition when the goods are brought into the FTZ.
Example 3: Assume that, in making the bulk photographic chemicals discussed in the example above, Acme imports $10,000 worth of an ingredient which, if imported directly, would be subject to duty at a rate of 3% ad valorem. By electing “privileged foreign” status for this ingredient, Acme could “lock in” the 3% ad valorem duty rate. When the finished photographic chemical is withdrawn from the FTZ for United States consumption, Acme would still pay duties on the value of this imported ingredient–but at the 3% ad valorem rate of duty which would have applied had this ingredient been imported directly into the United States, rather than at the 8.5% duty rate which would be applicable to the finished photographic chemical.
FTZ operators may request both “privileged” and “nonprivileged foreign” status for different imported ingredients used to make a single product in an FTZ. Thus, in the examples given above, Acme could elect “nonprivileged foreign” status for the nigrosine dye and “privileged foreign” status for the other ingredient, thus insuring maximum duty savings.
Thus, in preparing a cost-benefit analysis of transforming existing facilities into a FTZ “subzone”, companies should begin by comparing the duty rates which would be applicable to the finished products made in the proposed subzone to the duty rates which would be applied to the various ingredients used in making those products, and evaluating the duty savings which could be achieved by electing “privileged foreign” status for ingredients which have a higher rate of duty than the finished product.
In addition, companies can calculate “cash flow” benefits of FTZ operations by measuring the usual interval between the time a product, component or ingredient is imported and the time a product made therefrom is ready for shipment out of the facility.
2. FTZ Tax Benefits: In addition to duty benefits, goods stored or manufactured in FTZs are by law exempt from state and local taxes, such as excise taxes, inventory taxes, floor stocks taxes and the like. Goods stored or manufactured in FTZs and subzones are considered to be in international commerce, and thus not Constitutionally subject to regulation by the states.
However, FTZ facilities are still subject to state and local real property taxes.
Where goods are imported into an FTZ, and used there to make products for export, no duties are ever charged. In many cases, this eliminates the need to pay duties up front, and file duty drawback claims later. It also increases the attractiveness of FTZs as inventory sites for goods destined to several foreign markets.
Procedures for Seeking FTZ “Subzone” Status.
Should a company determine that it would benefit by obtaining FTZ “subzone” status for some or all of its United States facilities, it would ask the grantees of appropriate general purposes FTZs to submit to the Foreign Trade Zones Board an application to designate the company’s facilities as “subzones” of the general purpose FTZs. While the company seeking subzone status would prepare the applications, they would be technically submitted in the name of the FTZ grantee. In making such an application, it is always helpful to enlist the support of political leaders, including interested Congressmen, the Governor of the state where the facility is located, and even local elected officials.
Upon receiving the subzone application, the Board will publish a notice in the Federal Register soliciting public comments thereon. It will also designate a committee of Government officials to review the application and survey the facility.
The FTZ Board has the power to deny any FTZ application or limit any proposed FTZ operation which, in its judgment, would be detrimental to the “public interest”. For example, the Board has steadfastly refused to allow FTZ procedures for operations which circumvent antidumping or countervailing duty restrictions, or quotas. If no serious objections to the subzone applications are received, the Board will issue a subzone grant Requests for grants to establish manufacturing FTZ subzones generally take between 9 and 15 months for processing.
After the subzone grant has been authorized, the FTZ grantee must secure the facility to protect the revenue (i.e., prevent the unauthorized removal of merchandise from the premises on which appropriate duties have not yet been paid), and establish procedures with local Customs officials to govern the operation of the subzone once “activated”. Customs generally requires that FTZ and subzone operators establish an computer interface with Customs; this is easily and inexpensively done.
FTZ and Subzone Procedures
When a company has been authorized to operate its factory as an FTZ subzone, it must implement security and inventory control measures adequate to insure that the Customs revenues will be protected. The designated FTZ area must be appropriately secured. The company’s receiving and inventory records must be maintained in an appropriate FTZ format. When the subzone operator intends to withdraw finished products from the FTZ Subzone, it must file with the Customs Service an FTZ Withdrawal for Consumption, together with payment of appropriate estimated Customs duties, and must await Customs’ formal “release” authorizing the company to move the goods out of the subzone. Most FTZ releases can now be generated by computer, and do not materially delay the withdrawal of merchandise from a subzone.
In addition, FTZ and subzone operators must file an “Annual Report” with the FTZ Board, summarizing activities at the subzone during the year.
Where goods are manufactured in an FTZ, the Customs Regulations allow the FTZ user or operator to made a single “weekly entry” of all goods withdrawn from the FTZ for domestic consumption within a given seven (7)-day period. This helps to simplify the administration of zone operations. It can also yield additional savings, since the entire weekly entry is subject to the $485 “per entry” cap on the Merchandise Processing User Fee (MPF).
The Customs Service has recently proposed regulations which would expand this weekly entry option to non-manufacturing FTZ operations as well. This should enhance the attractiveness of using FTZs for distribution and other non-manufacturing operations.
Benefits of FTZ Status:
As noted above, companies manufacturing products in FTZ subzones can realize a number of important benefits. These include the following:
(1) Duty savings resulting from “inverted tariff” benefits, as discussed above;
(2) Deferral of payment of Customs duties until after imported materials have been used in manufacture, and finished goods are ready to be withdrawn for consumption;
(3) Elimination of need for duty drawback programs with respect to exported merchandise. (The cash flow from FTZ operations is superior to that realized in drawback, since the importer need not make an “up front” payment of Customs duties);
(4) Exemption from, or deferral of, many state and local taxes.
Obviously, there is some added expense associated with operating a company’s facilities as an FTZ subzone; however, many companies have found that these added costs are more than offset by the long-term tariff benefits available.
Firms interested in FTZ operations should consult the Customs Service’s recently-issued Foreign Trade Zones Manual. This document is an extensive compilation of the laws, regulations and procedures applicable to FTZs and subzone. While it contains far more extensive information than companies will need to prepare an FTZ cost/benefit analysis, it will companies some idea of the function and purpose of operating a manufacturing facility as an FTZ subzone. Copies are available from our offices.
Note: The information contained in this memorandum is for general information only, and is not intended as advice or counsel regarding any specific situation. If you have an issue relating to the subject matter discussed in this memorandum, you should consult with counsel or your customs advisers concerning the proper course of action to be followed in your case.
Entire contents copyright 1998 by Neville, Peterson, LLP.
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