Duty Drawback: Fundamental Concepts and Techniques

I. What Is Drawback?

1. Direct Identification Manufacturing Drawback

Traditionally, drawback was a refund of duties paid on materials or components which were previously imported into the United States and used here in the manufacture or production of goods for export. The goal of the drawback law was to encourage the production in the United States of articles for export, thereby stimulating United States foreign trade and assisting United States industry and labor.

Example Assume that Acme Corporation imports 100 electric motors, paying United States customs duties of $100 ($1.00 per motor). It brings the motors to its Albany, New York factory, where they are assembled with other components to make 100 winches, each containing one motor. After manufacture, Acme Corporation exports 50 of the winches to customers in various foreign countries. Acme is entitled to claim a drawback equal to 99% of the duties paid on the motors incorporated into the exported winches, or .99 X $50 = $49.50. This traditional type of drawback is provided under Section 313(a) of the Tariff Act of 1930, as amended [19 U.S.C. Section 1313(a)], and is known as direct identification manufacturing drawback.

2. Substitution Manufacturing Drawback

Over the years, the Congress has expanded the concept of drawback. Section 313(b) of the Tariff Act [19 U.S.C. Section 1313(b)] provides forsubstitution manufacturing drawback. Under this statute, a drawback of duties is payable with respect to imported, duty-paid components or materials, even if goods are produced for export with other foreign or domestic components or materials of the “same kind and quality” (“SKAQ”).

Example: Acme Corporation imports 100 electric motors, paying United States customs duties of $100 ($1.00 per motor). It brings the motors to its Albany, New York factory, where it also maintains an inventory of domestic-origin motors of the “same kind and quality”, as well as imported, duty-free SKAQ motors manufactured in a Caribbean Basin Initiative beneficiary country. Acme then manufactures 100 winches, each containing one motor, and exports 50 of these to foreign customers. Perhaps the exported winches all contain domestic SKAQ motors; perhaps Acme cannot identify the source of the motors incorporated into the exported winches. Nonetheless, Acme is entitled to a drawback equal to 99% of the duties paid on imported motors, as if those motors had been used to manufacture the 50 winches for export, i.e., .99 X $50 = $49.50. However, the total drawback paid may not exceed 99% of the total duties paid on imported materials. Thus, if Acme Corporation imported 100 motors as above, and produced 125 winches for export, its maximum drawback recovery would be .99 X $100 = $99.

Congress recently amended the drawback statute to provide for payment of manufacturing drawback upon the destruction, under Customs supervision, of “drawback merchandise”.

3. Direct Identification Same Condition/Unused Merchandise Drawback

In 1980, Congress amended the drawback law to provide for “same condition” drawback, a refund of 99% of duties, fees and taxes paid with respect to imported merchandise which is subsequently exported (or destroyed under Customs supervision) within three years after its date of importation, without having been changed in condition or used in the United States prior to such exportation or destruction.

Example: Acme Corporation imports 50 generators, paying Customs duties of $500 ($10 per generator). Two years after importation, Acme finds that it only needs 30 of these generators, and exports the remaining 20 to a foreign customer. The exported generators are in the same condition as when imported, and have not been used in the United States. Upon compliance with applicable Customs Regulations, Acme may claim a drawback equal to 99% of the duties, fees and taxes paid on the exported generators, i.e., .99 X $200 = $198. This is known as “direct identification same condition drawback”.

Recently, Congress amended the drawback law, replacing the “same condition” drawback provisions with new provisions for “unused merchandise” drawback. In direct identification cases, these changes dispense with the requirement that a product be exported in the “same condition” as when imported, and expand the list of incidental operations which may be performed without disqualifying a product for drawback. These changes became effective with respect to claims for drawback filed on and after December 8, 1993, as well as for claims filed before that date, but which were not liquidated and final as of December 8, 1993.

4. Substitution Same Condition/Unused Merchandise Drawback

In 1984, Congress again amended the drawback law to provide for “substitution” same condition drawback. Under this procedure, a company may recover a 99% drawback of duties paid on imported merchandise, if, within three years, it exports “fungible” domestic or foreign merchandise. The exported “fungible” merchandise must be in the same condition as the merchandise which was imported, and may not have been used within the United States prior to its exportation. “Fungible” merchandise is defined as merchandise which is for all purposes commercially interchangeable with the imported merchandise.

Example: Acme Corporation imports 1000 “Type X” transistors, paying duties of $200 thereon. Within three years, Acme exports 1000 domestically-made “Type X” transistors. The exported transistors are completely fungible with the imported transistors, are in the same condition as the imported transistors, and have not been used in the United States. Upon compliance with applicable Customs Regulations, Acme may claim a drawback equal to 99% of duties paid on the imported transistors, i.e., .99 X $200 = $198.

Here again, Customs recently amended the drawback law, replacing “same condition” drawback with “unused merchandise” drawback. The standard of “fungibility” has been replaced with a more liberal standard of “commercial interchangeability”. In addition, the list of “incidental” operations which may be performed has been expanded. These changes are effective for all drawback claims filed on or after December 8, 1993, and any claims which were filed before that date, but which were not final as of that date.

Section 313 of the Tariff Act provides for several other types of drawback, but manufacturing and same-condition drawback are by far the most important, in terms of both transaction volume and dollars.

II. Drawback a Privilege, Not a Right

The courts have uniformly ruled that the allowance of duty drawback is a privilege, not a right. Drawback claimants must follow exactly all of the procedural requirements for claiming drawback set forth in the Customs laws and regulations.

Thus, careful attention to detail and accurate recordkeeping systems are required in establishing and administering corporate duty drawback programs.

III. Duties, Taxes and Fees Subject To Drawback

In the case of manufacturing drawback, a 99% refund is payable in respect of all ordinary Customs duties paid, as well as special marking duties and internal revenue taxes which are assessed upon importation (e.g., Federal Excise Taxes imposed on tires). However, drawback of the 0.17% ad valorem “Merchandise Processing User Fee” is not available under manufacturing drawback.

In the case of same condition/unused merchandise drawback, a 99% refund is payable in respect of all ordinary Customs duties paid, as well as special marking duties and internal revenue taxes assessed upon importation. In addition, a 99% drawback of “Merchandise Processing User Fees may be obtained.

Prior to 1988, antidumping and countervailing duties could also be included in a claim for drawback. However, the Trade and Tariff Act of 1988 amended the drawback law to exclude antidumping and countervailing duties from drawback eligibility.

Beginning January 1, 1996, duty drawback (except direct identification same condition/unused merchandise drawback) will no longer be payable in respect of goods exported to Canada. Beginning January 1, 2001, a similar termination of drawback will become effective in respect of goods exported to Mexico. These “drawback sunset” provisions result from the terms of the North American Free Trade Agreement (FTA). However, a new “NAFTA drawback” regime will be create, to permit exporters to continue claiming drawback on a limited basis, and to avoid double taxation of firms engaged in North American international trade.

Moreover, effective January 1, 1994, the United States, under the terms of NAFTA, ceased paying substitution same condition/unused merchandise drawback in respect of goods exported to both Canada and Mexico. However, it is possible to claim many of these drawbacks using direct identification procedures and NAFTA-approved accounting methods to trace fungible commingled goods.

IV. Amount Of Potential Drawback Available

While the United States has granted duty drawbacks in various forms since 1789, duty drawback is still relatively underutilized. Government and industry sources estimate that approximately $3 billion in potential drawback refunds are available annually. However, only about $600 million in drawback refunds are actually paid out each year, suggesting that up to $2.4 billion in drawbacks go unclaimed.

In our judgment, one reason for the relative underutilization of drawback is that American manufacturers and exporters often do not think about the “drawback potential” of goods, materials and components they purchase from foreign and domestic suppliers, and do not realize that they may be eligible for drawback. In order to better evaluate drawback potentials, companies should be aware of (1) who is entitled to claim drawback in particular situations, and (2) when and how drawback rights are transferable.

V. Payment of Drawback: Assignability

By law, drawback is payable to the exporter of “drawback products” — whether or not the exporter is the person who paid the duties for which a refund is claimed. Thus, if Beta Corporation exports a drawback-eligible widget it purchased from Acme Corporation, Beta is the party to whom drawback is paid — even though Acme may have paid the duties for which a drawback refund is claimed. The law’s unspoken assumption is that the price paid by the exporter for the widget is a fully costed price which reimburses the seller for customs duties paid.

However, in order to claim drawback, an exporter must furnish Customs with three basic items of information: (1) proof of exportation; (2) information concerning any manufacturing conducted in the United States [e.g., reference to drawback contracts]; and (3) information concerning the import entries in respect of which a drawback refund is claimed. In essence, a “paper trail” must be constructed, connecting imported duty-paid goods to the exported “drawback product”. Where the importer, manufacturer and/or exporter are different entities, a certain amount of cooperation is required in order to complete claims for drawback.

An essential document in creating this “paper trail” is the Certificate of Delivery (“CD”), which documents the transfer of imported duty paid goods, materials or components, or the transfer of “drawback products” to an exporter or other purchaser. When a firm uses imported duty-paid (or substituted) merchandise to manufacture drawback products, it furnishes a Certificate of Manufacture and Delivery (“CMD”) to the transferee of the drawback product.

A few examples may help illustrate how these essential paper trails are created.

Example 1: Acme Corporation imports a cement mixing machine, paying duties of $5,000 thereon. Within three years, it sells the machine, in its condition as imported and without having been used in the United States, to Beta Corporation, which exports it. Acme furnishes a CD to Beta for the cement mixing machine, and Beta claims a same condition/unused merchandise drawback equal to 99% of the duties which Acme paid, or $4,950.

Example 2: Import Supply Corporation imports polypropylene yarn, paying duties in the amount of $20,000. Import Supply Corporation then sells the yarn to Verybig Manufacturing Company, which uses it to manufacture carpets. Import Supply Corporation furnishes Verybig Manufacturing with a CD, showing the Customs entry covering the imported yarn. Verybig Manufacturing Company then sells the carpets to Exporters, Ltd., furnishing a CMD. Exporters, Ltd. then exports the carpets, claiming a drawback equal to 99% of the duties paid by Import Supply Corporation, or $19,800.

In some instances, multiple manufacturing operations and transfers of materials or products may be involved. These can be document through CD and CMD procedures.

Example 3: Commodities, Inc. imports a shipload of refined sugar, paying Customs duties of $100,000. It sells this sugar (providing a CD) to Sweet-Tooth Soda Company, which uses it to make syrups for soft drinks. Sweet-Tooth Soda Company then sells the syrups (providing a CMD) to Sweet-Tooth Bottling Southwest, which uses the syrup to manufacture sodas. In addition to the syrup, the sodas incorporate caffeine imported by Sweet-Tooth Bottling Southwest, for which duties of $3,000 were paid. Sweet Tooth Bottling Southwest then sells the finished sodas (providing a second CMD) to Lucky Trading Company, which exports them. Lucky Trading Company is eligible to claim a 99% drawback of duties paid on both the imported sugar and the imported caffeine. [Thus, ($100,000 + $3,000) X .99 = $101,970].

Thus, companies which believe their operations have drawback potential should not only seek a refund of duties which they themselves pay, but should require their foreign and domestic suppliers to furnish them with Certificates of Delivery (or Certificates of Manufacture and Delivery) wherever applicable.

In many instances, buyers and sellers enter into agreements whereby the seller reserves the right to claim drawback, or where the parties agree to divide drawback refunds among themselves. In the case of manufacturing drawback, exporters may simply assign their right to claim drawback to another party, usually the seller of the drawback products. In the case of same-condition drawback, Customs has taken the position that the exporter must in all instances be the drawback claimant; however, this position has been rejected by the courts.

Where a drawback claimant has established a record of filing repeated claims which are free from serious error, it may ask Customs to authorizeaccelerated payment of drawback. Under the “accelerated payment” program, Customs will pay drawback refunds to claimants shortly after the claim is filed, without waiting for the import entry or the drawback claim to be “liquidated” and made final. The claimant furnishes a bond to secure Customs against the accelerated payment of excessive drawback, and may be required to repay to Customs accelerated drawback payments found to be excessive.

VI. Drawback Rules and Procedures

Having provided a basic outline of drawback benefits, it is appropriate to consider in more detail the rules and procedures applicable to the major forms of duty drawback. For good order’s sake, we will consider manufacturing drawback and substitution drawback separately.

1. Manufacturing Drawback

As noted above, drawback was traditionally defined as a repayment of duties paid on imported components or materials which are used in the United States to manufacture goods for export. Customs has generally taken a liberal view of what constitutes “manufacturing” for purposes of the drawback law.

Among the thousands of operations which Customs has deemed to constitute “manufacturing” for drawback purposes are the following:

Refining of crude petroleum into motor fuels, heating oils, and other finished petroleum products;
Simple assembly of imported components with each other, or with domestic components, to produce a new and different article;
Dyeing or printing of fabrics (with drawback claimed as to fabrics and/or dyestuffs, as appropriate);
Manufacture of shotgun cartridges from imported powders;
Manufacture of transistors from imported integrated circuits;
Recording of programs onto blank video or audio cassettes;
Electrolytic manufacture of aluminum, using imported electrodes which are consumed during the manufacturing process;
Programming of imported EPROMS and PROMS with software.

In order for manufacturing duty drawback to be paid, the manufacturer must enter into a “drawback contract” with the Customs Service. This contract must identify (1) the imported merchandise which will serve as the basis of the drawback claim, (2) the product(s) to be produced in the United States with the imported merchandise (or “same kind and quality” merchandise), (3) the manufacturing process to be conducted, (4) the facilities where manufacturing will take place, and (5) the manufacturing, inventory and other records which the manufacturer will maintain to document its drawback claims. In addition, the manufacturer must agree to abide by the laws and regulations governing drawback, and to make its books and records available for inspection by Customs officials at reasonable times. Acceptance of a proposed drawback “contract” is an undertaking that Customs will pay drawback if the claimant follows the procedures outlined in the contract and abides by applicable regulations.

For certain common operations (assembly of components, petroleum refining), Customs has established general drawback contracts. Interested manufacturers may subscribe to these drawback contracts by writing to Customs identifying their proposed operations and agreeing to abide by the terms of the general drawback contract.

After a drawback contract has been approved, an exporter may file claims for drawback upon the exportation of qualifying goods. Where there are a large number of individual drawback claims (or a large number of transactions giving rising to drawback rights), drawback may, with the permission of Customs, be claimed according to an “Exporter’s Summary Procedure”. Manufacturing operations may be summarized in a schedule, or in a manufacturing abstract, depending upon the nature of the manufacturing operation. Time constraints for claiming manufacturing drawback are as follows:

The claimant must export the completed article within five years after importation of the imported, duty-paid merchandise which serves as the basis of the claim;
Where “substitution” manufacturing drawback is claimed, the imported and the substituted goods must be used in manufacture withinthree years after receipt of the imported merchandise;
The drawback claim must be filed and completed within three years after exportation of the drawback product; and
The manufacturer must retain its records for at least three years after the drawback claim is paid.

2. Same Condition/Unused Merchandise Drawback

Unlike manufacturing drawback, it is not necessary for a drawback claimant to enter into a “contract” with the Customs Service prior to filing claims. However, at least five working days prior to the scheduled date of exportation, the drawback claimant must furnish the Customs Service with notice of exportation on Customs Form 7539 (drawback claim). The purpose of this advance notice is to permit Customs to inspect the goods prior to exportation, to insure that they are in the “same condition” as when imported (or, in the case of substitution same condition/unused merchandise claims, to insure that the exported goods are “commercially interchangeable” with the imported duty paid goods which serve as the basis for drawback).

The requirement of giving a notice of exportation may be waived by Customs (or the notification period may be shortened). However, failure to provide such notice, or to obtain a waiver of inspection, will be fatal to the drawback claim, regardless of its merits.

In the case of substitution same-condition/unused merchandise drawback, it is usually necessary to obtain a ruling from Customs concerning the “commercial interchangeability” of the imported duty-paid and exported “substituted” merchandise.

Critical time periods for claiming same-condition/unused merchandise drawback are as follows:

The imported goods (or the “commercially interchangeable” goods) must be exported within three years after importation of the goods for which drawback will be claimed.
At least 5 working days prior to exportation, notice of exportation must be given to the District Director of Customs on Customs Form 7539.
The drawback claim must be completed within three years after exportation.

VI. Other Types Of Drawback

The Customs laws provide other types of duty drawback which are less commonly used than the types described above. Nonetheless, it is appropriate to list them here. They are as follows:

Drawback of duties paid on merchandise not conforming to sample or specifications (“rejected merchandise drawback);
Drawback of internal revenue taxes paid on alcohol used to make flavoring extracts, medicinal or toilet preparations for exportation;
Drawback of internal revenue taxes paid on bottled distilled spirits and wines which are exported;
Drawback of salt used for curing fish;
Drawback on salt used in curing meats which are exported;
Drawback on imported articles used to build vessels for foreign owners or registry;
Drawback on imported parts and materials used to repair, rebuild or overhaul jet engines of foreign origin.

VII. Conclusion

The above is merely an outline of the duty drawback laws. Each proposed drawback operation must be considered on its individual merits, and careful attention must be given to insuring that all applicable laws, regulations and documentary requirements are observed.

Still, the cash refund potentials of duty drawback are enormous, and most companies which invest the time and effort needed to set up drawback programs quickly recoup their investment and enjoy substantial cash benefits.

Note: The information contained in this memorandum is for general information only, and is not intended as advice or counsel regarding any specific situation. If you have an issue relating to the subject matter discussed in this memorandum, you should consult with counsel or your customs advisers concerning the proper course of action to be followed in your case.

For additional information concerning the subjects discussed in this Neville Peterson LLP background memorandum, please contact our offices at (212) 635-2730 or (202) 861-2959, or e-mail using the mailbox on this Website.

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