A Short Guide to Customs Risk

Catherine Truel

• Publisher: Routledge
• Year: 2017
• Print ISBN: 9781138435957
• eBook ISBN: 9781351961813
• Topic: Business
• Subtopic: Business General
• Index: Business

The historic growth in world trade, large container ships and information technology have triggered profound changes in international trade. A few years ago, customs officers at the border were meticulously checking goods and documents before releasing a shipment to the trader. A business could be confident that a shipment that had cleared customs complied with all applicable regulations. Today, to reduce congestion and give the trade quick access to their goods, customs have introduced risk management principles and a large number of shipments clear customs automatically. Controls have moved from the border to the trader's premises and it is during site visits that customs officers check the business compliance records. Moving from frontier checks to audit based controls has transferred a high level of responsibility and risk to the trader. It is now the duty of the trader to identify and report any error or irregularity and to keep an impeccable audit trail from initial quotation to receipt of payment. For the business, failing to provide satisfactory compliance records will result in delayed shipments and serious disruption in the supply chain. This will in turn impact on financial performance indicators such as Days in Inventory, Days Sales Outstanding and of course Cash Flow. The business will also have to endure in depth customs audits during which customs officers will inspect each step of the audit trail disrupting day-to-day business operation. Errors uncovered during these audits will yield heavy financial penalties and a customs debt. Ultimately, customs risk will impact on shareholders value. Customs and finance reporting should receive the same level of attention. However, if all companies check carefully their tax returns, only a few check their import or export declarations with the same scrutiny. Managing customs risk is often seen as a cost centre but it is also a source of competitive advantage. A sound customs management can reduce or remov

1 Customs Risk and the Business

In its Risk Management Guide, the World Customs Organization (WCO) defines a risk as 'the potential for non-compliance with Customs laws'. From the business perspective non-compliance with Customs laws will translate into three types of risks: regulatory risk arising from laws and regulations, fiscal risk concerned with the collection of duties and taxes, and security risk linked to the integrity of the supply chain.

The negative impact of Customs risk can take many forms:

• Operational: Production interruption or production shutdown, delay of a project from its critical path, disruption of the supply chain, loss of sales, increase in inventory costs, late delivery penalties.
• Financial: Recalculation of duty and taxes, retroactive duty and taxes assessment, financial penalties, penalties interests, increase in transaction costs, late payment, cash flow and working capital deterioration.

• Reputation: Customs risk reported through the accounts, negative press coverage, loss of customers and trading partners, negative impact on credit rating, loss of shareholders and market confidence.

While Customs compliance will brings several benefits:

• Operational: Faster clearance, increase in fluidity and speed in the supply chain, decrease inventory levels, improve sourcing strategies.
• Financial: Reduced amount of duty paid, ability to sustain profitability, better management of liquidity and cash flow, reduced borrowing, reduced cost of the goods sold.
• Reputation: New source of competitive advantage, good reputation, good media reports, good analysts review and good rating agencies analysis.

Customs management is a strategic asset to sustain the business. It must be embedded into the wider business planning because Customs risk has many sources across almost all functions.

Sources of Customs Risk by Business Functions

The global supply chain consumes a huge amount of skills, knowledge and expertise to run smoothly Most events and intermediaries across the global network will have an impact on Customs risk. Internally several departments will directly or indirectly affect the level of risk. The challenge is to link these functions within a multi-disciplinary compliance strategy. The main difficulty is often cultural. Accountants, buyers, sales and logistics are all coming from a different cultural business training and environment. This can create barriers to the cross-departmental collaboration the compliance chain demands.

In practice, Customs and trade compliance can be presented as a series of checkpoints where the global network must comply with demands made by various authorities across several jurisdictions. These checkpoints are conflicting with the principles of global supply chain management because they rely on a different vision. While the global supply chain aims at supporting a constant flow of goods, Customs operate on a transaction per transaction basis. From a Customs perspective, each consignment is treated individually and separately.

Strategic Management

The lack of interest from senior management is the most important and common source of risk. However, despite their best intention, senior executives might not yet have Customs risk on their radar. For instance, the lack of preparation for a change in regulation can disrupt the supply chain. Often, it is during a Customs audit that senior management discovers the business level of exposure to Customs risk. At a time when shareholders are showing an increasing interest in managing global risk, Customs risk needs to be integrated into the business risk management policies and be subject to internal controls.

A business that has decided to buy or sell abroad will be exposed to a new political, economic and cultural environment. A country wanting to attract a particular industry is likely to develop friendly Customs procedures toward that industry. On the other hand, import regulations can make access to a foreign market difficult or even impossible with high duty rates, additional documentary or controls requirements. Customs risk will, in part, depend on a country's trade policy and its import or export requirements. A very demanding set of import regulations specifically designed to keep foreign manufacturers out of the domestic market will increase Customs risk. If the market is due to open in the near future, the objective of the business might be to gain market share and the compliance costs might be a strategic investment. Again, the key is to include Customs and trade risk at the strategic decision level. In some cases, a study of impact to identify Customs risk might uncover some substantial hurdles to an export market. Ultimately, trade policies and Customs regulations will influence the business global strategic decisions. They are at the heart of global sourcing and international sales.

Customs risk can suddenly appear as the result of a merger or an acquisition. Although the due diligence process should pick up any Customs debt, it usually focuses on tax risk and often does not consider Customs risk. The business could still inherit the history of a non-compliance business. This can range from weak internal processes to bad history with Customs authorities. This can affect companies being part of a Customs accreditation program such as the Authorised Economic Operator (AEO) or the US Customs-Trade Partnership Against Terrorism (C-TPAT). Customs risk can also hurt the business ambition of future mergers and acquisitions. Particularly in the US where the Sarbanes-Oxley Act requires, among other things, sound controls for the global supply chain. A business considering a merger or acquisition with a company listed in the US will have to demonstrate not only spotless compliance records but also sound internal procedures and controls. Corporate restructuring is often a source of Customs risk due to the changes it can bring to the valuation of transactions. Customs and tax authorities have different and conflicting methods to value cross-border transactions.

The choice of trading partners and the management of third party providers will affect the level of Customs risk. The relationship with the Customs agent or broker is critical. Many businesses hold the belief that they do not need to be involved with Customs formalities simply because their logistics provider handles the clearance. This might be right indeed if the logistics provider makes the Customs declaration in its own name. In this case, the logistics provider is the 'declarant' also known as the 'importer of records'. The declarant, in the eyes of the Customs authorities, takes all fiscal and compliance responsibilities. If a formal arrangement is not in place, it is very likely that the importer is the declarant. The high level of risk comes from the fact that the business has outsourced the Customs management function to a logistics provider, an agent or a broker without having any processes and controls to check the compliance level of the transactions made in its name. An extremely dangerous situation. Responsibilities between the business and the service provider must be contractually established. There should be some strong internal controls in place to mitigate this risk.

The business might also be exposed to export control regulations. The export of arms, defence articles and strategic goods is closely monitor by governments and will require a license. Export control applies not only to military products but also to dual-use goods that can be used for both civil and military purposes. Although Customs usually enforce export control, it is often managed by other government agencies.

Customs management is perfectly suited to strategic decision because it operates in a different time horizon from operations. While most functions will be looking at a 12 month time horizon, Customs management looks at 1-5 years ahead preparing for the next change in regulation. In the same way, in case of non-compliance, penalties will often go back several years.

The business level of Customs risk will vary depending on the industry, the product, the region, the countries of origin and destination.

Finance

If the finance department is not a great source of Customs risk, of all the business functions, Customs risk affects Finance the most. Mainly because fiscal risk is usually part of the finance director's job description.

The business financial and management accounting system is the tool supporting Customs control-based audits. Customs officers will audit the accounts to check that the information declared at clearance reflects accurately the transaction posted in the accounts. They will, for instance, check that transactions in accounts receivable and accounts payable match orders, invoices, shipping documents and payment. Processes in place to control authorizations for sign-off, credit notes and write-offs will also be of interest. Customs will look closely at inventory movements as well as the inventory value reported in the accounts. The Customs value is not necessary the invoice value. Some costs might be subject to duty and not be mentioned on the invoice. Customs will therefore be interested in cost accounting and cost elements such as treatment of discounts, royalties, financing agreements, commissions and all other service costs that can be associated with a transaction.

However, there is one instance where finance can be at the source of risk, in the case of inter-company transactions. If the business deals with another entity of the same group Customs will want to ensure that the relationship does not affect the value of the goods.

The business also faces the risk of missing an opportunity to reduce the amount of duty paid. This possibility is available only if Finance post Customs duties separately in the accounts. The lack of visibility of how much duty is paid, by product, by origin will not allow the business to identify areas hiding savings opportunities.

Procurement

The choice of sourcing country will influence Custom risk. For instance, a trade dispute can result in the introduction of trade defence instruments such as quota and anti-dumping duties that will result in higher cost and compliance requirements.

The choice of trading partners will also influence Customs risk. Particularly when procurement is done under the terms of a trade agreement. Trade agreements can require detailed product costing to comply with the rules of origin. This is often complex to set up and the supplier must have the capabilities to implement the agreement requirements. Otherwise, duties will be due at import. Furthermore, security requirements increasingly start at the supplier's factory from traceability to electronic seals. Supplier's relationship management must therefore incorporate Customs compliance. Ideally, suppliers' performance review should include compliance and security processes. Suppliers must also be kept informed of any change or new requirement in the importer's country. For instance, suppliers must now collect additional information to comply with US and EU new Advance Electronic Information Requirements.

Raising a purchase order on a foreign supplier has become the first steps of the import process. Any error at this stage can compromise the compliance chain. The purchase order can be a vehicle for compliance instructions. Some companies use it to mention compliance requirements such as: regular reporting on rules of origin, traceability, or marking requirements.

Misunderstanding International Commerce Terms (Incoterms) such as ExWork, FOB or CIF, is a common source of risk. Although Incoterms specify the point of transfer of risk, cost and ownership from the buyer to the seller, they do not cover Customs legal responsibility. The Customs responsibility will always lie with the declarant/the importer of record.

Sales and Customer Services

If the sale is done under the terms of a trade agreement the business will have to comply with the applicable rules of origin. This can be very demanding and evidence shows that some rules of origin can act as hidden protectionism. In this case, despite the trade agreement, the access to the foreign market might be restricted. Consequently, the level of protection in the export market will affect the level of Customs risk.

Optimizing the logistics might not be possible under the terms of a trade agreement as export orders might be subject to direct shipment requirement. Failure to comply with direct shipment instructions will result in the goods being denied reduced rate of duties at import.

For the sales team, the level of Customs risk will vary according to the export market political and economic environment. The sudden introduction of quotas or anti-dumping duties will increase the costs and affect the products competitiveness in the export market. A trade dispute is likely to introduce new requirements and increase the level of Customs risk.

If the business is subject to export control regulations then export orders will require specific attention and possibly a licence. Traders whose activity is affected by export control often use global trade management software to help sales and customer services automate checks required by the regulation. These applications will check products, destination, companies and people relating to the order against the several lists of restrictions. This, both at the time of receiving the order and at the time of export as the lists might have changed between these times.

Manufacturing, Repair and Service

Cross-border movements for repair, return, calibration, refill or product recall, use Customs procedures to ensure these transactions are duty free. These procedures are a source of risk, as they will demand strong data management to match the import with the previous export record. The compliance chain will have to track the movement of products sometimes across several borders.

Contracts including an installation abroad will pose a particular risk as products, parts, equipment and tools are likely to cross borders several times. The Customs risk arises from the volume of transactions that will have to be matched with each other to avoid paying duties on the same item several times.

Manufacturing and service often need exceptional consignments such as urgent spare parts, emergency orders, out of hour's shipments or hand carry. These shipments have usually to be arranged in a hurry. Without clear internal processes these transactions pose a risk of non-compliance and expose the business to Customs duties that could have been avoided. Furthermore, repair and service agreements do not always cover the Customs responsibility of returns to suppliers. This can lead to dispute on who pays duty and taxes for in warranty and out of warranty returns.

This department sometimes needs to set up an inventory of spare parts in the export market. This inter-company movement of products can pose a risk resulting from the valuation of the inventory and the value declared at Customs.

Finally, perhaps the most common source of risk from this department is the spare part or the tool thrown in the crate at the last minute before the shipment. The added item is often not mentioned on the invoice and therefore not declared to Customs.

Logistics

The logistics department has a special place in the compliance chain. It is the only department that has both a physical and documentary visibility of the movement of goods. It has therefore a responsibility to ensure that both the physical and documentary flows of goods are compliant. Furthermore, logistics is faced with all Customs risk. Consequently most decisions from this department can be a source of Customs risk.

In terms of security the physical flow of goods will provide several challenges. Some routes are safer than others. There are many places in a global supply chain where goods can be smuggled into a container. The business needs a security policy and procedures to mitigate this risk and protect the integrity of the supply chain. For instance, a secure warehouse.

Traders monitoring closely lost and stolen cargo can identify specific routes where these events occur. In the same way Customs know that certain points of the global network are weaker than others. They focus their attention on these locations where consignments have been shipped or transshipped. The choice of routing can therefore result in a higher inspection rate whether documentary or physical. In this case, the impact of the risk is the disruption in the supply chain with delay, loss of flexibility and responsiveness. The physical movement of goods could also pose a risk to trade compliance and contravene the direct shipment requirement of a trade agreement.

The document and information flows is the foundation of Customs management, so it has to be accurate and a true representation of the transaction. Weak record keeping from the logistics team is likely to result in non-compliance. There is an unwritten rule in...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Foreword
• Acknowledgments
• Introduction
• 1 Customs Risk and the Business
• 2 Customs Risk and Customs Authorities
• 3 Classification
• 4 Valuation
• 5 Preferential Rules of Origin and Trade Agreements
• 6 Customs Procedures
• 7 Security – The New Challenge
• Conclusion
• References