Against the background of a trade conflict, the conditions under the delivered duty paid (DDP) are being applied more often to avoid customs duty risks and lock in transaction costs. The “DDP delivery method” means that the exporter completes the import customs clearance procedures at the destination designated by the trading parties, and then delivers the goods to the importer. This article analyzes the customs value-determination risks under DDP trade conditions.
Rules of Chinese customs for price-determination of freight: cost, insurance and freight (CIF) and free on board (FOB). Item (2) of the first paragraph of Article 15 of the Measures for the Determination by Customs of the Dutiable Value of Imports and Exports (Order No. 213 of the General Administration of Customs; the “Value Determination Measures”) specifies that the following separately itemized taxes and expenses are not included in the prices of imports: costs of transport, associated expenses and insurance incurred after the goods reach the place of entry into and are landed in China. Item (2) of Article 40 specifies that the following taxes and expenses are not included in the dutiable value of exports: the costs of transport, associated costs and insurance incurred after reaching the point of departure in China and loading, if separately itemized in the price of the goods. The foregoing provisions show that customs’ basis for the determination of the value of imports is the CIF price and for that of exports is the FOB price.
Common errors seen in declarations under DDP. The amount under DDP is usually higher than that for CIF or FOB. Accordingly, many enterprises that use DDP will often extrapolate the CIF or FOB price based on DDP and declare this price to customs. Technically speaking, this is practicable for many enterprises. The author once visited a famous car manufacturer, which demonstrated how a piece of advanced customs declaration software could realize automatic translation between more than 10 trade terms. However, if an enterprise really does proceed in this way, it could incur penalties for violating regulations.
The main reason for the violation of regulations lies in the enterprise’s disregarding the requirement of the Value Determination Measures that the expenses be itemized separately in the price. Under DDP conditions, freight and insurance for the domestic and foreign legs are calculated together, making it impossible to accurately separate them. Even if the seller could separately secure transport and insurance contracts for the domestic and foreign legs before arranging for transport, the same still would not satisfy the requirements of the Value Determination Measures, i.e. that the separate itemization should be done by the buyer and the seller, not by the seller, carrier and insurer.
Accordingly, under DDP, all of the freight and insurance for the domestic and foreign legs is supposed to be folded into the dutiable price to determine the import/export duties and taxes. Compared with peers that use CIF to import and FOB to export, the burden on enterprises that use DDP is clearly greater, but this is due to the express provisions of the Value Determination Measures. Before commencing import/export activities, an enterprise should have an understanding of the attendant financial costs.
Dual secret and open contracts: flashing red light of smuggling risk. A misunderstanding of DDP will not only create a tax problem, but may also give rise to a smuggling risk. A small number of enterprises will, after executing a DDP contract and for the purpose of satisfying pro forma the requirement of separate itemization, break up the contract shortly before customs declaration and import, and themselves fabricate a sale and purchase contract based on CIF terms. It is entirely possible that proceeding in this manner could cause a violation of regulations and lead to charges of smuggling.
The existence of two sets of trade documents for a single trade activity is commonly referred to as “dual secret and open contracts”, and is one of the clear markers of smuggling. Such an act will result in a decrease in the dutiable value and thus in a smaller payment of duties and taxes. Under such a circumstance, the enterprise’s subjective intentional act is extremely clear and if the amount reaches a certain threshold, the crime of smuggling is constituted. Accordingly, once DDP trade conditions have been opted for, they should be steadfastly maintained, and making a false customs declaration to save on duties and taxes should be avoided.
From the perspective of the internal compliance of an enterprise, as customs, tax authorities and commercial banks may involve the reporting of tax related information, and could be handled by the corresponding customs affairs, tax and financial personnel of the company, this could give rise to a situation where the person responsible for a reporting is not aware of the information reported by the other departments, thereby increasing the risk of conflicting reports. Once the law enforcement authority gets its hand on the divergent information reported by the enterprise and points out the conflict between the reported information, trying to give a clear explanation becomes difficult. If improperly handled, the possibility could arise of different law enforcement authorities each imposing penalties.
Accordingly, it is necessary for an enterprise to strengthen reviews of the consistency of the information reported from different positions. Additionally, it should require its procurement, logistics, customs affairs and financial departments to cooperate closely and strengthen the compliance training of all personnel. Although their jobs differ, each relevant employee should be aware that different trade terms can affect the enterprise’s financial costs and that, during the entire process, from contract execution, customs declaration to the payment of foreign exchange to the foreign party, the enterprise’s phrasing of the trade terms must remain consistent. If each in conflict with the other, it is extremely likely that the result will be the imposition of penalties for a violation of regulations.
In short, the effect of the selection of trade terms is not limited solely to the rights and obligations under Uniform Customs & Practice for Documentary Credits (UCP), but the calculation and levy of duties and taxes under customs also changes accordingly. It behooves that an enterprise be well aware of the linkage between civil consequences and administrative consequences and to do a thorough cost and risk analysis before a transaction, as only in this manner can the objective of the transaction be realized to the greatest extent possible.
Wang Yongliang is an associate at AllBright Law Offices and is also a lecturer in the Faculty of Law of the Shanghai Customs College
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