By Carrie Zethmayr, President & Partner, Zethmayr
Since 2016, the global trade environment has continued to change at lightning speed. Global companies are localizing supply-chains due to protectionist trade policies and the restructuring has been expedited and cemented by the COVID-19 pandemic. Companies are filing exemption requests for imported commodities that don’t have equivalent domestic sources with some success and ability to recoup cash paid in tariffs. However, the uncertainty of future tariff rates leaves companies with significant risk, the enemy of planning. In this environment, companies with an established foreign trade zone (FTZ) strategy have had a competitive edge. Others are catching up, and some regions are seeing record numbers of new companies activating their facilities as foreign trade zones.
Companies and regions with proactive, user-friendly, foreign trade zone programs will become havens for global business. The tariffs are not going to disappear regardless of the outcome of the next presidential election, and companies are still going to require international trade even as aspects of supply-chains are re-shored. FTZs will allow companies to maintain competitive operations in the United States, mitigating risk of manufacturing moving to other countries that are not impacted by the tariff increases.
Companies use foreign trade zones in many ways, but the primary benefits are related to the deferral and potential reduction or elimination of import tariffs. In an era of 25 percent increases in tariff rates on imports from China, a main benefit is that companies can control when they pay the tariff to manage their cash. The ability to control and plan cash flow provides certainty to companies that will differentiate them from their competitors in uncertain times. Proactively enabling companies to implement FTZ strategies will similarly differentiate regions, especially to international firms seeking locations to establish their U.S. operations.
Program Overview
The FTZ program was established in 1934 by the Foreign Trade Zones Act, and has received consistent bi-partisan support for its impact on maintaining a competitive environment for manufacturing in the U.S. The purpose of the program is to create and maintain U.S. employment “through the encouragement of operations in the United States which, for customs reasons, might otherwise have been carried on abroad.”1 The program allows companies to create a restricted access area within their manufacturing and/or warehouse operations that is removed from U.S. customs territory for the purposes of duty collection and customs processing. This restricted-access allows them to transport imported product in-bond directly to their FTZ, deferring their tariff payment and customs entry procedures until after the product leaves their FTZ and enters U.S. customs territory.
At a minimum, a company’s tariff on imported product is deferred. If the product is re-exported with the same tariff classification outside of U.S. customs territory, the product effectively never entered U.S. customs territory and the tariff is eliminated. If a manufacturing process takes places, the same benefit is realized if the product is re-exported outside of USMCA territory.
Companies can also receive special approval known as “production authorization” to receive what is called an “inverted tariff benefit.” The inverted tariff benefit allows a company to pay the tariff rate on the product that is sold to the U.S. market, rather than the tariff rate on the products that were imported. For example, many heavy equipment products such as tractors and construction equipment have a 0% tariff rate. Caterpillar announced at the 2019 National Association of Foreign Trade Zones Annual Conference in Chicago they are implementing a FTZ strategy nationwide. With their final products available for sale to the U.S. market at 0% duty, an inverted tariff benefit would allow them to essentially eliminate the tariff on imported components and sub-assemblies. The benefit is maximized when the company’s suppliers are also FTZs, allowing for a zone-to-zone transfer pushing the benefits of FTZs down the supply-chain and further consolidating tariffs into a final product with a lesser duty rate. Any company that imports components and also supplies directly to Caterpillar, Kubota, CNH or John Deere or any other FTZ original equipment manufacturer might consider approaching their customer to see if they can become a more integral part of their supply-chain if they also became an FTZ, enabling zone-to-zone transfer.
The potential benefits vary greatly depending on the tariff classifications of the imported and final products, the countries of origin and destination. There are also regulations that prevent an FTZ from being used as a loophole around federal policy, such as Sections 232 Trade Remedies on aluminum and steel and Section 301 Trade Remedies on certain imports from China. The National Foreign Trade Zone Board, a division of the U.S. Department of Commerce International Trade Administration must approval all applications for production authorization, and they will not provide approval for “activity that is inconsistent with U.S. trade and tariff law, or policy which has been formally adopted by the Executive branch.”2 For example, let’s say a manufacturer imports subassemblies from China to assemble a tractor in the U.S. This hypothetical company could benefit from an FTZ strategy by (1) deferring their tariff payment until the product enters U.S. customs territory, and also by (2) eliminating tariffs on products re-exported outside of USMCA territory, because the product would never have entered U.S. commerce. However, the company will not be able to realize the inverted tariff benefit to eliminate the tariff on sales inside of the USMCA territory. Rather, the original tariff rate on the imported subassemblies will follow the tractor throughout the product’s assembly through a sale in North America. The purpose of this regulation is to prevent the FTZ program from being used as a loophole to undermine intentional policy of the executive branch.
Every single company has a unique fact pattern and situation and must therefore consult a trade attorney to gain a full understanding of how their company could potentially benefit from an FTZ strategy.
Benefits to Companies
As tariff rates sky-rocketed in recent years with new trade remedies, the foreign-trade zone program has been described as a “life-line” by companies with an FTZ strategy already in place. Despite companies being unable to use the inverted tariff benefit on imports impacted by trade remedies, having an FTZ already in place provided companies time, through the tariff deferral, to plan for how and when those products would be used. Cash flow was less impacted, while competitors were forced to bleed an additional 25 percent immediately. The ultimate benefit is that the FTZ provided these companies internal control, and mitigated risk. In today’s changing global environment, control and risk mitigation are integral to a company’s stability.
The section 232 and 301 trade remedies have spurred other companies to action to stop the bleeding, with some companies seeking to free multi-million-dollar figures that have been tied-up in tariffs. While the FTZ will not immediately free-up the cash, the company will be able to control future tariff payments to benefit from the cash flow savings over-time.
Other companies are using foreign trade zones for benefits that are completely unrelated to tariffs. Chicago Importing Company in Huntley, Illinois uses its foreign trade zone to enable its boutique suppliers in Scandinavia and Western Europe to sell their specialty-food products in the United States. You may see Chicago Importing Company’s international products in stores such as Ikea. The suppliers abroad are authentic small businesses that do not have the resources to invest in equipment and procedures to produce FDA-approved food labels. Without a foreign trade zone, the imported food products would not be allowed to enter the United States. As a foreign trade zone, Chicago Importing Company can import the food product in its pre-FDA approved packaging, transport the product in-bond to its warehouse in Huntley, and then add the FDA-approved labels. This enables an entire supply-chain of specialty food product that would otherwise be prohibited due to FDA labeling requirements. Other companies in food and pharmaceutical industries are able to conduct research and development on pre-FDA approved products to develop packaging and plan for the products’ eventual FDA approved distribution in the United States. As these examples show, the ultimate foreign trade zone benefits are flexibility and control over supply-chains, both which are increasingly important components of supply-chain planning.
Regional Economic Development Strategy
While the foreign trade zone program is nationally available, it is locally administered by federally authorized “grantees” that are typically local port authorities. There are over 251 authorized grantees across the United States located at ocean and inland ports—they are not limited in their national geography. The grantee plays an important role in enabling a regional strategy to use the foreign trade zone to help existing operations establish cost optimized facilities, and to attract new employers to the area that require a FTZ strategy to enable their global supply-chain. Grantees differ in their procedures, cost structure and outreach to enable companies to access the FTZ program. A site selection that is dependent on international trade should ensure a local grantee is available with a customer-service focused staff to enable FTZ access.
Foreign trade zones will be a powerful differentiation tool for regions and economic development organizations that proactively wield it to demonstrate their comprehensive approach to enabling total cost optimization in their region. In a time of supply-chain localization, foreign direct investment is becoming a focus of economic development organizations as international firms realize they need to establish U.S.-based operations in order to compete to serve in the U.S. market. While these global firms will look for local suppliers, many will also continue to source sub-assemblies and other components from their existing supply-chain abroad. Savvy firms are seeking to locate in regions that will enable them to use foreign trade zones to optimize their global supply-chain; economic development organizations must be ready to compete.
Certain states, including Texas, Kentucky and Arizona, can also offer the foreign trade zone as a method for companies to defer or eliminate certain ad valorem personal property (e.g. inventory) taxes that are imposed at a state or local level, potentially leveling the playing field when compared to states and localities that don’t impose the same tax.
A 2019 study commissioned by the National Association of Foreign Trade Zones found that establishing a new FTZ in a region (i.e. a region becomes authorized as a new grantee) “causes a positive increase in employment growth in the surrounding [Zone Economic Community] (up 0.2 percentage points), wage growth (up 0.4 percentage points), and value added growth (up 0.3 percentage points).”3 The impact of wage and employment growth are more immediate, while the more long-term impact comes in the form of increased value-added activity in a region attributed to the establishment of an FTZ. As regions compete to become a hub for advanced manufacturing activity, a foreign trade zone strategy will continue to be an important tool to attract the next generation of innovators.
Facility Expansion Optimization
For a company that is considering an expansion, a foreign trade zone is a tool that can be deployed as part of a comprehensive facility optimization strategy. During a site selection process, companies consider their supply-chain networks, study the labor force of a potential location, and evaluate tax climates all to ensure long-term sustainability through reduced operating costs. Alongside these variables, a foreign trade zone feasibility analysis should be considered as part of the site selection analysis to ensure cost optimization.
A commonly held misconception is that a company must be located at a specific geographic area to use a foreign trade zone, such as within a port district or near an ocean port. In fact, there are over 250 foreign trade zone grantees across the United States, most covering multi-county territories. A foreign trade zone strategy does not limit the site selection process and can be executed alongside a nationwide search. When speaking with communities, it will be important to ensure a relationship is developed with the FTZ administrator to ensure their implementation policies are user-friendly.
What Should a Region or Company do to Benefit
To compete for foreign direct investment, an economic development organization must not be caught flat-footed by a company that is looking for a location that will optimize its global supply-chain. An important first step is to assess whether your region is located within the service area of an existing FTZ, and if so, develop a close partnership with the administrator to ensure the program can be proactively offered to new and existing businesses. If you are not located directly in an existing FTZ service area, steps can be taken to authorize a new FTZ for your region.
As a company, if you are significantly impacted by tariffs or customs entry procedures, a foreign trade zone feasibility study can be completed, and if necessary it can be evaluated in the context of a comprehensive network analysis that will look at all global operations for the purpose of total-cost optimization. Sometimes a simple feasibility study can be enough to show significant windfall savings, and next steps can be taken accordingly.
Sources:
1 U.S. Foreign-Trade Zones Board, “FTZ Regulations,” 15 CFR Part 400, “Preamble,” “Summary,” 2012, https://enforcement.trade.gov/ftzpage/regs.html#400.27
2 U.S. Foreign-Trade Zones Board, “FTZ Regulations,” 15 CFR 400.27(a)(1) https://enforcement.trade.gov/ftzpage/regs.html#400.27
3 2019. The U.S. Foreign-Trade Zones Program: Economic Benefits to American Communities https://www.naftz.org/wp-content/uploads/2019/02/2019-FTZ-Economic-Study.pdf
About the Author: Carrie is the President of Zethmayr LLC, a site selection and economic development consulting company. Having worked with Foreign Trade Zone (FTZ) operators since 2012, Zethmayr LLC serves as the administrator of Foreign Trade Zone #176 in Rockford, Illinois under contract to the Greater Rockford Airport Authority.
Zethmayr LLC provides comprehensive facilities optimization services, including location strategy, financial incentive negotiation, and construction management. In its first year of operation, Zethmayr secured over $1.8 Million in financial incentives for an international client base.
A licensed real-estate broker, Carrie serves as Vice President of Consulting for Cawley Chicago, the largest independent industrial real-estate brokerage firm in Chicago. These services align to offer unparalleled, comprehensive real-estate solutions to industrial clients across the Midwest.
