How to Succeed with your China Tariff Exclusion Request (or not)

Back in June, Adams Lee (one of my fellow international trade lawyers) urged those who manufacture products in China for the U.S. to Get Going on Your China Tariff Exclusion Requests Now. 

Adams’ advice has clearly not gone unheeded. These days, client calls to discuss exclusion requests are as much a part of my morning routine as my first cup of joe. The deadline for filing List 3 exclusion requests is September 30, 2019, though one wonders why the United States Trade Representative (USTR) is even bothering with a deadline. According to a news report, the process for reviewing exclusion requests has “slowed to a painful crawl”,  noting that “USTR in July up to the 19th had completed work on just 60 of the total 2,900 requests for tariff waivers on the [List 2] tranche requests”.  Not a promising sign when trying to determine how long it will take to sort out the 60,000 List 3 requests for which USTR is bracing — never mind the looming List 4 requests, when essentially all China imports will be subject to tariffs.

Our clients are understandably interested in any patterns that are emerging regarding approvals. Thanks to the good folks at the Mercatus Center, we know List 1 requests for capital goods have been approved at a higher rate than intermediate goods or consumer goods, but for List 2 requests, consumer goods were approved at a higher rate than either capital or intermediate goods. It is important, however, to keep in mind that consumer goods account for only a fraction of the List 1 and 2 requests. More on this later.

Turning to the substance of the requests, after reviewing many of the requests adjudicated by USTR, it is clear approved requests tended to clearly articulate why the product for which an exclusion was sought cannot be sourced from anywhere other than China. I emphasize cannot because what trips up many requestors is that they end up explaining why they do not want to source from elsewhere.

For instance, take this denied tariff exclusion request from List 1:

[Company X] respectfully requests that you grant its request for an exclusion.

While we cannot seek exclusions on every component that we source from China, we are pursuing exclusions for several higher value and/or larger volume components, including this product.

[Company X’s] sourcing decisions are guided by a number of factors including availability of the part; quality of the part; landed cost… desire to work with a particular supplier; capacity of a supplier to produce volume needed on deadline; supply chain risk management; and minimizing capital investment.

*    *    *    *

Failure to grant [Company X’s] exclusion request will increase the company’s production costs. As a result, the company will reduce its margins, pass the additional cost onto consumers… negatively affect… the 60,000+ American workers [Company X] employs… (emphasis added)

Readers from my generation may remember the The Far Side, a brilliant comic created by Seattle’s own Gary Larson. One of my favorite cartoons juxtaposed what an owner said to his dog (“You stay out of the garbage! Understand, Ginger?”) with what Ginger actually heard (“blah blah Ginger blah”). To USTR (Ginger) this request is screaming, “I don’t want to pay more, blah blah”.

To be sure, paying more for products manufactured in China is a completely legitimate concern and I am not trying to make light of the real struggles faced by Company X and others that have their products made in China. But we are right now in a large-scale trade war with China (with no end in sight) and in the same way our grandparents were expected to buy Liberty bonds during World War I, the USTR expects businesses that ship China manufactured products to the United States (and  the buyers of those products) to bear economic burdens as the country “max[es] out [its] economic power.”

Company X’s tariff exclusion request (above) does passingly mention availability of its product outside China, but it fails to flesh out how that forces it to get that product from China. Is the product not available at all in a third country? Or is it available, but not at the sufficient volume or necessary quality?

It is worth keeping in mind that USTR largely avoided consumer goods in Tariff Lists 1 and 2, but consumer goods account for more than 30% of the List 3 products (compared to less than 1% in the first two lists). This shift could bring about a sea change in tariff exclusion rejection patterns. USTR has rejected just over 60% of the List 1 tariff exclusion requests and 45% of the List 2 requests it has received.

My suspicion is that the move towards consumer goods in List 3 will cause tariff exclusion rejection numbers to increase from Lists 1 and 2. One of the key issues for USTR when it considers exclusion requests is the following:

Whether the particular product [for which the tariff exclusion is being sought] is available only from China. In addressing this factor, requesters should address specifically whether the particular product and/or a comparable product is available from sources in the United States and/or in third countries.

A familiar theme in this blog is the shift of manufacturing activity out of China, primarily to Southeast Asia and to Mexico.  In How to Stop Manufacturing in China: Try Harder, we wrote how in many instances (but certainly not all), it is neither difficult nor expensive to move manufacturing outside China:

This probably sounds harsh, but many companies would benefit from moving their manufacturing out of China that have not yet done so for reasons more related to inertia than to economics or anything else. I realize change is hard but if you are in a situation where you are essentially paying 25% more than your competitors and at huge risk of your products being slapped with retroactive duties ranging from 20% to 250%, inertia is not a good excuse.

Of course, there are companies that have almost no choice but to have their products made in China. China has been developing its export-oriented capabilities for decades and its manufacturers enjoy access to a massive internal market and to levels of government assistance that cannot be matched in other low-cost destinations. As per a Quartz article:

Then there are the products the US almost exclusively gets from China. Raising tariffs on these goods will likely cost American consumers, and leave importers in a bind to find substitutes in the short-term—in the long-run, manufacturers may look to produce these goods outside China. We identified 11 product categories that China supplied 95% of US imports worth at least $100 million in 2018 by analyzing data from the US Census Bureau. All 11 product categories were on the list of goods for which the US has threatened to raise tariff rates by 25%. The US has since agreed to delay these hikes as part of negotiations.

By contrast, China’s manufacturing competitors have been flooding the lower ends of the value chain. Simply put, it is easier to set up a sneaker factory than a chemical processing plant. Back to Quartz:

The US imports about $100 million dollars in soy sauce every year. China supplies 42%. But it also gets a lot of soy sauce from Japan (17%), Hong Kong (14%) and Thailand (7%). If the US raises tariffs on Chinese soy sauce, importers might shift their buying to these other countries to avoid cost increases.

This means that when it comes to consumer goods, we expect fewer U.S. importers will be able to answer “No” to the key question in the exclusion request form: “Is this product, or a comparable product, available from source[s] in third countries?”. As a result, it can be fully expected that USTR will deny a higher rate of List 3 and List 4 requests.

What all of this means is that if you really need to source your products from China, you need to ensure that your tariff exclusion requests are as strong as they can be. On the flip side, what is happening with the tariff exclusion process is another reminder that the conversation about getting out of China needs to happen now, especially because we do not see the United States eliminating its China tariffs soon, if ever:

If your company is thinking there will be a solution to the US-China trade war and that solution will obviate any need to move your manufacturing from China, you are very likely engaging in wishful thinking. The US-China trade war has been going on for more than a year now and, if anything, we are farther away from resolution than when it started.

What is happening with the tariff exclusion process underscores this point. By now, everyone should have disabused themselves of any notion that  tariff exclusions would be an effective workaround. They will not, unless you can truly show that your product cannot be sourced in a third country. This is the time to recognize the difference between needing to source your product from China and preferring to do so.

If you need to stick with China and you are looking down at the tariff barrel, make sure you look at some of the approved tariff exclusion requests for inspiration and be sure to clearly spell out why you do not have a China alternative, remembering that “I would have to pay more” is not going to cut it. On the other hand, if you can source your product from somewhere other than China at comparable cost and quality, it is probably time for you to move on.

I will in the meantime be working on completing and submitting more tariff exclusion requests.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.