By Elise A. Couston, Senior Managing Director at Newmark Grubb Knight Frank
Foreign Trade Zones are currently experiencing double-digit growth in the U.S., as the value of freight moving through the FTZ’s rose 14% in 2012 over 2011 and exceeded $732 billion. This figure represents the most recent statistics currently available from the Department of Commerce, however the volumes have reportedly continued to gain momentum in the last 18 months.
The purpose of the FTZ program is to facilitate trade and increase the global competitiveness of U.S.-based companies. From a legal standpoint, Foreign Trade Zones are designated areas within the U.S. that the government considers outside of the U.S. Customs territory. In short, merchandise is imported into a Zone with less paperwork and without paying import duties.
WHAT DEFINES A FOREIGN TRADE ZONE? Located in or near Customs Border Patrol (CBP) ports of entry, they are the United States’ version of the internationally-known “free-trade zones”. Foreign and domestic merchandise may be moved into zones for operations, not otherwise prohibited by law, including storage, exhibition, assembly, manufacturing, and processing. Foreign-trade zone sites are subject to U.S. laws and regulations, as well as those of the states and communities in which they are located. Merchandise, which lawfully cannot be imported into the United States, is prohibited without exception. Furthermore, placing merchandise subject to a quota into a zone cannot circumvent quotas on the imported merchandise.
Many products subject to an internal revenue tax may not be manufactured in a zone. These products include: alcoholic beverages; products containing alcoholic beverages, except domestic denatures; distilled spirits; perfumes containing alcohol; tobacco products; firearms, and sugar. In addition, the manufacture of clock and watch movements is not permitted in a zone. No retail trade of foreign merchandise may be conducted in a FTZ. However, foreign and domestic merchandise may be stored, examined, sampled, and exhibited in a zone.
There are currently 230+ FTZs in the U.S., of which 8 are in Illinois. Some of the IL zones include the following: • FTZ 2 is in Chicago and includes Ford, BP, Northrop Grumman, Crate and Barrel and Sony • FTZ 31 is in Granite City and includes Daimler Chrysler and Phillips Petroleum • FTZ 176 is in Rockford and includes Nissan, Daimler Chrysler and Unicarriers America
The benefits for the FTZ users are: • Duty Exemption. No duties on or quota charges on re-exports. Customs duties are never paid on merchandise exported from a Zone; • Duty Deferral. Customs duties and federal excise tax is deferred on imports. Imports may be admitted and held in a Zone without paying U.S. Customs’ duty. This improves cash flows for companies located in an FTZ; • Inverted Tariff. In situations where zone production results in a finished product that has a lower duty rate than the rates on foreign inputs (inverted tariff), the finished products may be entered at the duty rate that applies to its condition as it leaves the zone (requires prior authorization); • Logistical Benefits. Companies using FTZ procedures may have access to streamlined customs procedures (e.g. “weekly entry” or “direct delivery”) which can result in improved inventory management and increased visibility of the supply chain; • Other Benefits. Foreign goods and domestic goods held for export are exempt from state/local inventory taxes. FTZ status may also make a site eligible for state/local benefits which are unrelated to the FTZ Act. Duties are eliminated on materials subject to defect, damage, obsolescence, waste or scrap. Spare parts may be stored, returned, or destroyed without any duty payment.
The permitted activities in a Foreign Trade Zone are: • Merchandise in a zone may be assembled, exhibited, cleaned, manipulated, manufactured, mixed, processed, relabeled, repackaged, repaired, salvaged, sampled, stored, tested, displayed and destroyed; • Production activity must be specifically authorized by the FTZ Board. Production activity is defined as: “any activity involving the substantial transformation of a foreign article or activity involving a change in the condition of the article which results in a change in the customs classification of the article or in its eligibility for entry for consumption”; • Retail trade is prohibited in zones.
DEVELOPING AN FTZ The U.S. Foreign Trade Zones program was authorized by Congress as the FTZ Act of 1934. This was one of two important pieces of legislation that were enacted in 1934 in an effort to limit some of the negative effects of the Smoot-Hawley Tariffs, which were imposed in 1930. The Foreign-Trade Zones Act is administered through two sets of regulations: the FTZ Regulations (15 CFR Part 400), and CBP Regulations (19 CFR Part 146). This new legislation raised U.S. dutiable tariffs (not including duty-free imports) on over 20,000 imported goods to the highest levels in over 100 years.
Despite the fact that President Herbert Hoover was opposed to the bill and had some serious concerns about it, he succumbed to political pressure from his party and business leaders, and signed the legislation. As a result, boycotts broke out, and foreign governments moved to increase rates against American products. President Hoover’s fears were well-founded, as Canada and other countries raised their own tariffs in retaliation after the bill became law. In May of 1930, the U.S.’s largest trading partner, Canada, retaliated by imposing new tariffs on 16 products that accounted for about 30% of all U.S. exports to Canada.
Both Senator Smoot and Representative Hawley were defeated in the elections of 1932, as the depression worsened for workers and farmers, despite their promises of prosperity with a high tariff. U.S. imports decreased 66% from $4.4 billion (1929) to $1.5 billion (1933), and exports decreased 61% from $5.4 billion to $2.1 billion, both decreases much more than the 50% decrease in the Gross Domestic Product. Net exports declined from $1 billion to $600 million, while GDP was $58.9 billion.
From 1934 and until after World War II, FTZs were only used on a very limited basis because of the prohibition against manufacturing activity, and the zones were dormant for about 16 years. The post-WW II Smoot-Hawley levels reflected a general tendency for the U.S. to unilaterally reduce its tariff levels while its’ trading partners retained their higher levels. The American Tariff League Study of 1951 compared the free and dutiable tariff rates of 43 countries. That study found that only 7 countries had a lower tariff level than the U.S. (5.1%), while 11 nations had free and dutiable tariff rates higher than the Smoot-Hawley peak of 19.8%, including the United Kingdom (25.6%). The 43-country average was 14.4%, which was 0.9% higher than the U.S. level of 1929, demonstrating that few nations were reciprocating in reducing their levels as the U.S. reduced its own.
In 1970, there were 8 Foreign Trade Zone projects, with a total of 3 Subzones, in the United States. These Zones are used to help encourage activity and “value-added” at U.S. facilities, in competition with foreign alternatives, by allowing delayed or reduced duty payments on foreign merchandise.
While merchandise within a zone is considered outside the customs territory of the U.S., this is for formal entry procedures only. Foreign merchandise in a zone is within the territory and jurisdiction of the U.S. and is considered “imported”.
Since 1972, the National Association of Foreign Trade Zones (NAFTZ) has served the interests of companies and communities who participate in the FTZ program. NAFTZ has pushed for equivalent tariff treatment of products manufactured in a U.S. foreign trade zone environment. The NAFTZ asserted that Customs duty on products manufactured in the Zones should not be assessed on the “value-add”, i.e. the value which consists of domestic materials, parts, labor, overhead or profit. In 1980, the U.S. Customs Service issued a formal ruling that agreed with the NAFTZ’s position. Finally the FTZ program could help to attract and retain U.S.-based economic activity.
TODAY’S GROWTH According to the Journal of Commerce, there are many reasons for the growth of shippers using the Zones and the amount of freight moving through them. The zones benefit companies that are importing goods into the U.S. and adding value to them, whether that is a U.S. component or altering them for specific customer specifications (i.e. tinting auto windows).
New regulations now make it easier for companies to use the Zones by allowing them to receive FTZ designation in 30 days or less, rather than the previous eight month time-frame.
Since 2008, companies can bring an FTZ designation to existing facilities instead of having to locate no more than 60 miles or a 90-minute drive from the port of entry. These changes helped to enable more than 400 companies to take advantage of the FTZ’s across the U.S. in 2012, increasing the total number of users of approximately 3,200.
As manufacturing in the U.S. continues to grow, we will most likely see a continuing increase in the number of Foreign Trade Zones and Subzones that are expanded and established. An FTZ location has the ability to level the playing-field for companies by reducing costs and increasing U.S. competitiveness in the global economy. Helping local companies to remain competitive will enable users to boost their employment and increase investment in U.S. facilities, which is beneficial for growth in our business and the overall economy.