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Trade Compliance

What is Duty Drawback? A Guide to Claiming Duty Drawback

Duty drawback is the process by which eligible duties, taxes, and fees that have previously been paid upon importation of goods are returned to an individual or company.

Grant Sernick

Director of Sales at 3rdwave

What Is Duty Drawback?

Duty drawback is the process by which eligible duties, taxes, and fees that have previously been paid upon importation of goods are returned to an individual or company, once satisfactory supporting information has been provided to the government.

Way back in the age of kings and queens, a kingdom’s primary method of generating revenue for the treasury was to collect duties. Duties were effectively taxes on goods entering the kingdom, as the king or queen believed that they were entitled to compensation for allowing foreigners’ goods to enter the commerce of their kingdom.

Although we no longer live in a world governed by kings and queens, little has changed from an international trade perspective.

Given that duties are taxes levied by governments for goods entering the commerce of their territory, what happens when goods actually do not enter commerce? Should the importer not be entitled to have those duties returned to them?

As it turns out, the answer is yes. There are circumstances in which duties can be returned to an individual or company that paid them if and when the goods did not make it into commerce.

This begs the question: why? Why would someone import goods that never make it into the commerce of a territory? There are an infinite number of answers to this question, but the most common have been catalogued and organized into the following reasons:

  • Goods were imported and then subsequently exported (i.e., sold into another market)
  • Goods were imported and subsequently destroyed (i.e., instead of being sold)
  • Goods were imported and returned to the vendor
  • Good were imported, transformed into something different, and subsequently exported

In all of these cases, someone is likely capable of getting the duties and fees returned.

Duties, Fees, and Taxes

Hundreds of years ago, duties may have been the one line item that needed to be paid when goods were entering a country. However, we now live in a complex world, and for better or worse, governments have determined how to charge importers incrementally, without adjusting duty rates.

Duties are taxes that are applied to goods being imported. Duties are typically ad velorem, meaning they are calculated based on the value of goods, multiplied by a certain duty rate. The duty rate is defined in a country’s tariff book, which is a highly technical document that is hundreds of pages long, and attempts to define anything and everything that could possibly be imported. The tariff book has evolved over time, and is incredibly complex.

Figure 1.1 - The Tariff Schedule

As a result of the complexity, there is an accredited profession dedicated to understanding the language of duties. These people are called licensed customs brokers (LCBs), and are accredited by Customs and Border Protection in the United States, or Canadian Border Services Agency in Canada. LCBs are able to complete customs-related work on behalf of their clients. When LCBs are employed by companies to represent their organizations, they are referred to as trade compliance professionals.

In order to determine the duty rate that is applicable to any good being imported, a Harmonized Tariff Schedule (HTS) classification is required. The HTS defines anything and everything that could possibly be imported, and the challenge becomes finding the appropriate ten-digit HTS code for the good being imported. That is where an LCB comes into play. They are experts in this tariff schedule who are able to decipher the often cryptic language of the HTS code.

Once an HTS code has been determined, the duty rate can easily be found against the HTS code.

Section 301 Tariffs

In the United States, Section 301 of the Trade Act of 1974 is one of the principal statutory means by which the government can assert its rights for unfair foreign barriers to US exports. 

In addition to import duties, there are additional fees and taxes that the government is able to assess. Certain fees apply generally, while other fees and taxes apply only to certain commodity classes. Moreover, there are fees that apply only to specific modes of transportation. Here is a quick list of the most common fees you might encounter:

  • Harbour Maintenance Fee (HMF): Applies to goods arriving by ocean
  • Merchandise Processing Fee (MPF): Applies to all goods being imported
  • Excise Tax: Applies to certain goods, including alcoholic beverages, tobacco, etc.
  • Cotton Fee: Applies to cotton and cotton-related goods
  • Goods and Services Tax (GST) or Value-Added Tax (VAT): A general consumption tax that applies in certain countries like Canada and Australia

HTS and Schedule B Codes

The Harmonized Tariff Schedule (HTS) is a ten-digit code used for classifying all imported products. In the United States, the HTS code is called the HTSUS and is administered by the US International Trade Commission (USITC). There are more than 21,000 ten-digit HTS codes in the United States.

The Schedule B code is similar to the HTSUS code, as it is also ten digits. The first six digits will be the same, as they are both predicated on the Harmonized System (HS). However, the Schedule B codes are administered by the US Census Bureau. 

It is important to know when to use the HTS code and when to use the Schedule B. A trained customs specialist can help you determine this.

Reasons for Drawback

The possibility for drawback exists when duties have been paid and when the goods are not sold within the territory for which the duties have been collected. There are several primary reasons for why this could happen:

  • Goods are subsequently exported (i.e., sold to a party outside of the territory)
  • Goods are destroyed
  • Goods are returned to the vendor

Although the reasons for drawback are reasonably straightforward, there are many complications that can arise that create regulatory and process-related complexity.

What happens if a company is an importer and not an exporter? Alternatively, what happens if a company is an exporter of goods that were previously imported, but is not an importer themselves? Provided that any one transaction is not used more than once, anybody can pull the claims together from various parties to create a drawback claim. 

This can culminate in an artifact of US Drawback called drawback trading, through which an importer is paired with an exporter for a similar commodity. In this example, while the importer pays duty on their goods, they do not export. Conversely, the exporter of the goods never paid duty, so there is nothing to drawback. However, when you pair the two together, they are able to make a valid drawback claim and split the refund. This type of transaction is often organized by a broker that is able to find both the importer and exporter to pair together. The drawback recovery is typically split between all three players.

Types of Drawback

In the United States, the regulations enable drawback of different types, with the three most common types being:

  1. Unused Merchandise Drawback — This is used when imported merchandise is not used in the United States prior to being exported or destroyed (under CBP supervision). 
  2. Manufacturing Drawback — This is used when imported components are used in an exported finished product or assembly. 
  3. Rejected Merchandise Drawback — This is used if merchandise is rejected due to defect, if it does not meet a specification, or if it was shipped without consent. In this instance, the merchandise can be returned or destroyed (under CBP supervision).

For both Unused Merchandise Drawback and Manufacturing Drawback, there are two different subgroups known as Substitution and Direct Identification:

Substitution

Historically, substitution referred to the ability of a claimant to substitute commercially interchangeable parts. So, if a widget was imported, and a domestically produced similar widget was exported, you were able to recover duties as the products were commercially substitutable. 

Previously, the regulation was reasonably strict with the definition of commercially interchangeable, requiring the same part number. With the recent introduction of TFTEA, the requirements for being interchangeable have changed, such that it is defined as having the same HTS at the eight-digit level. This means that when a part is exported, provided it is the same eight-digit HTS number as an imported part, you are able to claim drawback on it. 

As an example, let us imagine that you are a wine company. You own vineyards in both Napa and Tuscany. When you export a Cabernet from California, you are able to claim back the duties (and fees/taxes) that were paid on the Chianti that was imported from Italy. You can do this because they are the same HTS code at the eight-digit level.

Direct Identification (Direct ID)

Direct ID is when a specific widget that was imported is able to be tracked directly to the export of that same part or inventory lot. When you are able to trace the lifecycle of these parts, you can claim back the duties, fees, and taxes.

Although this seems simple in concept, most companies do not have the systematic capabilities to accomplish this feat. As a result, the government makes certain concessions to enable this provision of the drawback regulations. When companies are unable to specifically trace parts through their inventory systems, they are able to use accounting rules to determine which exported parts are available for drawback claim (and conversely, which parts are not available). For a more in depth discussion, see here.

Direct ID drawback becomes more intricate when dealing with transformations such as manufacturing. When component parts, for which duty has been paid, are incorporated into finished parts, the duty from the components can be drawn back if the company is able to track these parts through the manufacturing process. Again, when this is not possible, accounting rules can be used. The data challenges when this is the case are quite significant.

Automated Commercial Environment (ACE)

When a drawback claim is finalized, a drawback broker must file the drawback claim to CBP using the Automated Commercial Environment (ACE). This is CBP’s portal through which data is passed for filing and government review. 

Access to ACE is controlled by CBP to approved software providers that have passed the validation process. These software packages are known as automated broker interfaces (ABIs). 

Data Requirements

The global supply chain is comprised of many unrelated parties working on separate, yet related elements to achieve desired outcomes. As a result, information and data from the supply chain is copious, yet decentralized and unrelated. Drawback requires that all of this information is centralized, connected, and validated. 

This data typically falls into three different categories: import, export, and corporate data, such as inventory or bills of material. 

Although the exercise of centralizing, connecting, and validating data can seem onerous, the regulations make it clear that the information required to support a drawback claim should be data kept in the usual course of business. 

Import Data

The import data to support a drawback claim is identical to the import data required to support an import filing. Specifically, it is required that companies are able to substantiate the elements of the imported shipment, which includes a bill of lading, packing list, and commercial invoice. It would be impossible to execute the import without this information, and because the import customs broker would be unable to fulfill their responsibilities without this information, it is typically obtainable even if this is not an activity completed by the trade compliance group.

Companies that have a robust import program through which import data is monitored (i.e., audited) and centralized should have little problem bringing this information together.

Export Data

Export data can be more difficult to bring together and substantiate. Similar to the import, it is important to have a commercial invoice and packing list for every export shipment. This is typically easily achieved, as these records are part of the corporately controlled dataset. 

Proof of export is the final piece of the puzzle, and this is typically achieved by way of an export bill of lading. This can sometimes be a challenge for a couple reasons:

  • Carriers sometimes do not retain their records for extended periods of time. This is especially true with small parcel carriers, where their retention policies can be no more than six months.
  • In many international shipments, the customer is responsible for the transportation of goods in what is known as a routed transaction. In such instances, the carrier is working on behalf of the customer, and not the seller. As a result, it can become very difficult to acquire the bill of lading or proof of delivery. Often, you must work with your customer to obtain it. In many cases, there are so many shipments that it is not practical to do this activity.

Corporate Data

A connection between the import and export is often required. This can sometimes be achieved through an inventory lot record. Other times, especially when transformations are involved, this must be accomplished through bills of material. Good data is required, as it relates to both the inventory lots and/or bills of material.

Finally, all sales order information could be required, regardless of whether they are domestic or international orders. 

Documentation

In many instances, documentation is required to support the data. This is required any time there is some kind of transaction in which a third party validates the information, such as a bill of lading, a packing list, a commercial invoice (i.e., for product sent to you on import), a bill of lading on export, or a proof of delivery on export.

Although this documentation is not required to create the actual drawback file and claim, should you be audited, CBP will ask for this supporting documentation. If you are unable to provide it, it is likely that your claim will be rejected, and penalties may be assessed.

Validation Requirements

Trade compliance is all about being able to support any data that is provided to the government with an audit trail to substantiate the data. Duty drawback is no exception. In fact, the requirements for drawback extend well beyond typical auditing that you might have for an import or export program. 

In a typical import or export program, you would select a subset of total entries (e.g., import) or declarations (e.g., export) and review a certain set of data elements and documentation to ensure that your process is operating within a defined set of tolerances. Non-conformances are highlighted, and the process can be systematically amended and improved in the hope of eliminating repeating non-conformances.

With duty drawback, however, the requirements are dramatically more stringent. It is imperative that the data and documentation are centralized, consistent, and connected both forward and backwards through its lifecycle. It is important to be able to validate data from the import all the way through to the export, and similarly from the export all the way through to the import. 

Failure to get the data and documentation organized and validated appropriately can result in serious penalties and fines that could materially impact the financial performance of your business. It is for this reason that drawback brokers are able to charge their fee, as they typically ensure that this hurdle is overcome.

Challenges

Getting a company’s import, export, and corporate data centralized, connected, aligned, and validated is fraught with a number of challenges that are very difficult to overcome. The primary tool that people use to tackle these challenges is the spreadsheet. While the spreadsheet is by far the best tool that exists today, as we shall see it is highly ineffective. 

Disconnected Data Sets

The real difficulty with drawback is that you need to make sure that all data floating around your supply chain matches and supports your drawback claim. This means that you need documented support of your data that comes from a myriad of different places. The problem, as anyone who has ever dealt with data can tell you, is that whenever data comes from separate places, it invariably does not match—or matching everything up is incredibly challenging.

This is the problem with drawback. The data sources include bills of lading (from forwarders and carriers), commercial invoices (from vendors), packing lists (from consolidators), and customs entries (from customs brokers and ACE). 

Aggregations at Different Levels and Perspectives

Perhaps the most notable challenge that one would face when working on drawback is how to connect the data from different data sets together. Here is the problem: your corporate records are managed by SKU or product/part number, which I will now refer to as SKU. ACE data, which has been filed with CBP, is organized by HTS code, or even worse, at the summary level of HTS code. Reconciling this information is a total headache.

Here is an example. Let us imagine an apparel company that sells t-shirts. The shirts come in S, M, and L, and are available in five colors: white, black, blue, yellow, and red. That would work out to 15 different SKUs. All of these t-shirts, however, fall under the same HTS code. Within your corporate records, you would have 15 SKUs, with supporting documentation (e.g., PO, inventory record, etc.) for those 15 SKUs.

Within ACE (CBP’s record), there would be only one record, which would be the HTS code (6109.10.00.07) with a quantity, value, and duty paid. 

Somehow, within your data records, you will need to figure out how to match the 15 SKUs with the HTS code. 

Now, imagine that you have hundreds or thousands of t-shirts, pants, sweatshirts, and other items that fall into dozens of different HTS codes. The reconciliation task is monumental, and the spreadsheet, your only tool, is not effective.

Multiple Sources of Data

Data may sometimes be your challenge, but more often the bigger challenge is that you have data from multiple sources. Multiple sources of data create a big headache for drawback analysts because different sources create problems. 

Let us imagine that you have more than one customs broker on the import side. You will need to get an import report from each broker, and when that data is forwarded to you, each one will look quite different. It will be your job to normalize that data. 

However, you also have multiple freight forwarders, possibly multiple ERPs, and so on. Acquiring the datasets on their own can be a huge burden, as your ability to influence the various service providers can often be limited. 

Normalizing Data

While not the precise definition, normalizing data is the activity of structuring datasets such that they are easy to use and manipulate. When data is received from different service providers, they will be received in different formats, with some datasets having superfluous information. Other datasets will be missing certain data.

Some datasets will be received already aggregated in a certain way, while others will be not aggregated at all. 

Getting the data normalized such that it is consistent and usable can take a lot of work. 

Validating Data

Perhaps the biggest data challenge when tackling the drawback exercise is the validation of data. How do you know that data is correct? How can you identify that there is a discrepancy that must be remedied?

The solution to this problem lies in one’s ability to understand what each and every data element is, and how it is connected to the data upstream and downstream from it. 

Overcoming this challenge requires that you have already solved most of the challenges we discussed above (e.g., data acquisition from multiple sources, the data aggregation challenge, normalizing data, etc.). However, it also requires that you now are able to link the various datasets one to the next. In certain instances this can be easy; however, it can be a huge problem in others. 

Linking Imported Products to Finished Exported Products

Getting through the data challenges listed above can be daunting. Should you be sufficiently adept at navigating these rough waters, you are going to meet a challenge that can often be the most serious of challenges: linking your inbound products to your finished (i.e., exported) products. This is accomplished through either your inventory records or bills of material. In either event, it is not easy.

If your exercise is to defend a J1 (direct identification) claim, your goal is to link the inbound shipments and product through an inventory lot to the exported shipment. In this instance, the product has not changed form. The challenge is to be able to connect the imported shipment and commercial invoice data (from the import data) to the inventory lot to the sales order, commercial invoice, and bill of lading data (from the export data). 

This is not the biggest challenge if your inventory management system and warehouse processes manage the inventory lots accurately and that the data is available to you. To be precise, your ERP must be capable of connecting the inbound shipment to the warehouse receipt to the inventory lot to the sales order. For some, this is easily done. For others, this presents a real challenge. 

For those of you looking to create a manufacturing drawback claim, the goal is to link the inbound shipments and product through a bill of material (BOM). While this exercise requires all of the elements described in the J1 example, the BOM is another dataset that requires connecting. The ERP needs to be able to connect the inbound shipment to the warehouse receipt to the inventory lot to the BOM to the sales order. 

One additional piece that must be accounted for (and could really be its own subheading) is that the BOMs typically need to be managed with validity dates, as BOMs often change over time. It is your responsibility to make sure that the right BOM is used in this process, and that is not always obvious or explicitly tracked.

Make Duty Drawback Claims Easy With 3rdwave

In recognition of the drawback opportunity that now exists, 3rdwave has developed a duty drawback solution that drives the entire process. Enabled by a unique Product Master Database and powered by algorithms that automate both data compilation and matching of exports to imports, 3rdwave allows claimants to capture every penny of drawback that they’re eligible for.

With the costs of running a business constantly going up, merchants have to always be looking for ways to ship to new customers without losing their shirts. While lots of companies squeeze profits out of traditional cost-control measures like shipping, the fact is that duty drawback is grossly underused by U.S. companies. In fact, according to U.S. Customs & Border Protection, upwards of $3 billion a year is lost in unclaimed drawback refunds.

So, if you run a company that imports goods from overseas and then sells them to customers outside the U.S., you absolutely have to get on the “Drawback Train”. It’s your money, it’s 100% legal and is a great way to keep costs in line and profits in your pocket.