In ruling NY N312202 (June 18, 2020), Customs and Border Protection (CBP) discussed the classification of the Plus Bionics POD. It is a composite machine that has several features including facial recognition, temperature reading, disinfection, an LCD display and alarms for high temperature readings. When entering the unit, the user will place their face in front of the facial recognition camera, which identifies the user and displays their information on the LCD display. The device will then use a thermal imaging camera to provide an accurate temperature reading of the user. If the body temperature exceeds the standard, a voice alarm will be given. The temperature results are also displayed on the integrated LCD display. The user then proceeds to the disinfecting booth. The Plus Bionics POD utilizes an ultrasonic atomizer and fan to create a disinfecting fog that disinfects the user. An indicator light will go on when the disinfecting is initiated and will go off when the disinfecting is complete. Finally, the user opens the curtain and steps out of the booth.

General Rule of Interpretation (GRI) 3(a), HTSUS, states that the heading which provides the most specific description shall be preferred to headings providing a more general description. However, when two or more headings refers to only part of the machine then those headings are to be regarded as equally specific in relation to the function of the machine. As per Note 3 to Section XVI, composite machines consisting of two or more machines fitted together or machines designed for the purpose of performing two or more complementary or alternative functions are to be classified as if consisting only of that component which performs the principal function. In this instance, principal function cannot be determined. According to General Explanatory Note (VI) to Section XVI, titled “Multi-Function Machines and Composite Machines”, when it is not possible to determine the principal function of the machine as provided for in Note 3 to Section XVI, and when the context does not otherwise require, it is necessary to apply GRI 3(c). Thus, the Plus Bionics POD is classifiable in the subheading, which occurs last in numerical order among those which equally merit consideration. In this instance, the temperature reading component falls within heading 9027.

CBP determined that the applicable subheading for the Plus Bionics POD will be 9027.50.4020, HTSUS, which provides for “Instruments and apparatus for physical or chemical analysis (for example, polarimeters, refractometers, spectrometers, gas or smoke analysis apparatus); instruments and apparatus for measuring or checking viscosity, porosity, expansion, surface tension or the like; instruments and apparatus for measuring or checking quantities of heat, sound or light (including exposure meters); microtomes; parts and accessories thereof: Other instruments and apparatus using optical radiations (ultraviolet, visible, infrared): Other: Electrical: Thermal analysis instruments and apparatus.” The general rate of duty will be free.

Pursuant to U.S. Note 20 to Subchapter III, Chapter 99, HTSUS, products of China classified under subheading 9027.50.4020, HTSUS, unless specifically excluded, are subject to an additional 25 percent ad valorem rate of duty. At the time of importation, the Chapter 99 subheading, 9903.88.01, in addition to subheading 9027.50.4020, HTSUS, must be reported.

 

On May 29, 2020, President Trump announced his intention to direct his administration to begin the review and removal of Hong Kong’s special treatment for dual-use export controls.  Over the last week, we have seen the U.S. State and Commerce Departments begin to implement these changes through a coordinated series of announcements that, collectively, represent the largest change in Hong Kong’s status under export control laws since the 1997 handover ending British sovereignty.

Specifically, on June 29, 2020, the U.S. State Department announced that it will “end exports of U.S.-origin defense equipment and will take steps toward imposing the same restrictions on U.S. defense and dual-use technologies to Hong Kong as it does for China.”  On the same day, Secretary of Commerce Ross announced, “Commerce Department regulations affording preferential treatment to Hong Kong over China, including the availability of export license exceptions, are suspended. Further actions to eliminate differential treatment are also being evaluated.”

On July 2, 2020 the Commerce Department’s Bureau of Industry and Security (BIS) formally announced the suspension of all license exceptions for all exports and re-exports and transfers in country to Hong Kong that provide different treatment than those available to China.  Essentially, the announcement limits available license exceptions for Hong Kong to only those that are also available for China.  Items already prepared for loading, on a carrier, or en route to Hong Kong may proceed under the prior license exceptions.  Similarly, deemed export transactions to Hong Kong previously authorized under these licensing exceptions   may proceed until August 28, 2020.  After which, deemed exports to Hong Kong will have licensing requirements.

Among the more significant changes are:

  • License Review Policy:  BIS currently has a more favorable case-by-case licensing policy for exports to Hong Kong, whereas exports to China involving military end uses or end users, or crime control items, are subject to a licensing policy of denial if the exports will “make a material contribution to the [PRC] military capabilities.”
  • License Exception APR:  License Exception APR for additional permissive re-exports found in section 740.16 of the EAR is available for re-exports of items subject to the EAR from Wassenaar member countries and from Hong Kong, which although not a Wassenaar Arrangement member, complies with the principles of the arrangement.  Under license exception APR, items may be exported from Country Group A:1 (Wassenaar member states) and Hong Kong to Hong Kong and other A:1 countries for end use in those countries.  Certain items are also permitted to be re-exported to other country groups and NS-controlled items are permitted to be exported to country group D:1 which includes the PRC.  BIS  has proposed an amendmentto APR which would eliminate China (and other D:1 countries) from eligibility for re-exports under APR (see our prior alert here).  If this amendment is adopted, and Hong Kong becomes a D:1 country rather than an A:1-like country, NS controlled items would require a license for re-export to Hong Kong.  Additonally, the termination of Hong Kong’s A:1-like status would result in license requirements for other items re-exported from Wassenaar member states.
  • License Exception STA:  Hong Kong is currently designated as an A:6 country.  These countries are eligible for exports under license exception STA (Strategic Trade Authorization) found in section 740.20 of the EAR.  Under STA, certain items may be exported to countries in groups A:5 and A:6 provided that the exporter obtains certain written statements from the consignee among  other procedural requirements..  Although Hong Kong currently remains an A:6 country, as a result of the June 30, 2020 changes to license exceptions available to Hong Kong, it will no longer be eligible for any exports under license exception STA.
  • License Exception GOV:  License Exception GOV, EAR section 740.11(c), allows exports of certain items to NATO members and other “cooperating governments.”  Hong Kong is currently one of the cooperating governments and was eligible to receive exports under License Exception GOV.  However, the new changes will eliminate this license exception from those previously available for exports to Hong Kong.
  • Hong Kong Import License Requirements:  Currently, under section 748.13, exporters to Hong Kong are required to include either (a) import licenses from Hong Kong or (b) statements from the Hong Kong government that no import license is required, when the exporter is applying for a license for items subject to the EAR and controlled for NS, MT, NP1, or CB reasons.  Similarly, re-exporters of items subject to the EAR and controlled for NS, MT, NP1 or CB reasons must obtain an export license from Hong Kong or a statement from the Hong Kong government that no export license is required.  However, these requirements are expected to be eliminated because exports to Hong Kong will be treated as exports to China.
  • PRC License Requirements: Treating exports to Hong Kong as exports to China will not only entail the loss of certain advantages but also the imposition of additional burdens by the application of special requirements for the PRC.  Under section 748.10 of the EAR, exports to the PRC  valued at more than $50,000 that require a license (as well as licensed 6A003 cameras valued at more than $5,000, and licensed computers of any value) must include with the license application a PRC End-User Statement issued by the Chinese Ministry of Commerce (MOFCOM).  Exports to Hong Kong will also be subject to the recently revised Military End User and End Use provision of section 744.21.

What to Watch for

Additional changes to both the ITAR and EAR will likely be announced soon.  In the meantime, those exporting and re-exporting items subject to the EAR to Hong Kong would be well-served to closely examine their activities with respect to Hong Kong, including any upcoming shipments, in light of the recent announcements, and prepare for possible interruptions or suspensions to their business.

New Business Guidance to Address Supply Chain Risks and Considerations

The Departments of State, Treasury, Commerce, and Homeland Security issued guidance on July 1, 2020 titled “Risks and Considerations for Businesses with Supply Chain Exposure to Entities Engaged in Forced Labor and other Human Rights Abuses in Xinjiang” (the “advisory”).  The advisory broadly recommends that businesses with potential exposure in their supply chain to the Xinjiang Uyghur Autonomous Region of China (“Xinjiang”) be aware of the reputational, economic, and legal risks involved with conducting business in the region and implement human rights due diligence policies and procedures to address the risk.  The advisory highlights that since March, 2017, more than one million ethnic Uyghurs, Kazakhs, Kyrgyz, and other Muslim minorities have been held in internment camps designed to eradicate the detainees’ cultural and religious identities and to indoctrinate them with Chinese Communist Party ideology.  Detainees have been subject to overcrowding, sleep and food deprivation, medical neglect, physical and psychological abuse, forced labor, sexual abuse, denial of religious practices, and forced studying of Communist Party propaganda.

The advisory recommends businesses and individuals remain aware of these abuses and urges them to evaluate exposure to risks, implement due diligence policies, procedures, and internal controls to ensure compliance practices are appropriately accounting for potential risk throughout supply chains.  The advisory identifies three primary areas of risk: (1) assisting in developing surveillance tools for the Chinese government in Xinjiang; (2) relying on labor or goods sourced in Xinjiang in their supply chains, given the prevalence of forced labor and other labor abuses in the region; and (3) aiding in the construction of internment facilities or manufacturing facilities in close proximity to them.

A number of potential indicators of forced labor are laid out in the advisory.  Of note for businesses is a lack of transparency among firms operating in Xinjiang and factory location.  These firms often use shell companies to hide the origin of their goods, use contracts with opaque terms, and conduct financial transactions that make it difficult to determine where the goods were produced or by whom.  Factories built near internment camps, within their confines, or in industrial parks nearby are often additional indicators that forced labor may be utilized.

Businesses are recommended to collaborate with each other and with industry groups to exercise leverage in conducting human rights due diligence.  Businesses should examine the end users of their products, technology, research, and services to reduce the likelihood that they are being used to advance the human rights abuses in Xinjiang.  Furthermore, businesses providing construction materials to Chinese entities that may be operating in Xinjiang are encouraged to conduct due diligence practices to reduce the likelihood that internment camps are the ultimate beneficiaries of their business.  These due diligence efforts should be well-documented in the event that businesses inadvertently engage in sanctionable activity or activity that violates U.S. law.

Despite the importance of due diligence efforts, the advisory points out the challenges presented with doing so.  In particular, third-party audits may not be as reliable a source of information in Xinjiang as they typically are.  At issue are repeated instances of auditors facing detention and harassment, the use of government translators who convey misinformation, and interviews with workers that may be unreliable.  The advisory suggests that businesses pool and share information to better identify and assess indicators of forced labor.

While the penalties for the use of forced labor are varied, the advisory focuses on the use of Customs and Border Protection prohibitions against importing and benefitting from supply-chain related use of goods produced with forced labor.  Penalties may include civil or criminal actions, including denying entry to goods produced with or benefitting from forced labor, seizure and forfeiture of such goods, and the issuance of penalties against the importer and other parties.  Criminal investigations may be opened to prosecute individuals and/or corporations for their roles in the importation of goods into the U.S. in violation of U.S. law.

Uyghur Human Rights Policy Act of 2020

Prior to the issuance of the guidance, on June 17, 2020, President Trump signed the Uyghur Human Rights Policy Act of 2020 (the “Act”).  The Act aims to address human rights violations and abuses by the Government of the People’s Republic of China (“China”) through the mass surveillance and internment of over 1,000,000 Uyghur and other minority ethnic groups in Xinjiang.  The Act was passed with broad bipartisan support, passing the Senate unanimously and clearing the House in a 413-1 vote.

The Act requires the President to submit a number of reports to Congress providing detailed information on the scope and perpetrators of human rights abuses in Xinjiang.  In particular, the Act requires the President to submit a public report to Congress within six months and annually thereafter identifying any foreign person and official of the Government of China that is responsible for the denial of human rights in the Xinjiang Uyghur Autonomous Region.  Sanctions will then be imposed against each individual identified in the President’s report.  Such sanctions shall include blocking the property of identified individuals and denying admission to the United States.  Importantly, these sanctions shall not include the authority or a requirement to impose sanctions on the importation of goods into the U.S.

In addition to sanctions, the Act requires the Secretary of State to submit a public report, within six months, on human rights abuses in Xinjiang Uyghur Autonomous Region to Congress.  The report must include detailed information regarding the number of individuals detained in internment camps; a description of the conditions in such camps, including an assessment of methods of torture, efforts to force individuals to renounce their faith, and other human rights abuses; the number of individuals in forced labor camps; methods used to reeducate detainees in the camps, including identification of government agencies in charge of reeducation; an assessment of the use of forced labor and a description of foreign industries and companies benefitting from such labor; an assessment of the level of access to the Xinjiang Region granted by China to foreign diplomats and consular agents, independent journalists, and representatives of nongovernmental organizations; an assessment of the mass surveillance, predictive policing, and other methods used to violate the human rights of persons in Xinjiang; a description of the frequency with which foreign governments are forcibly returning refugees and other asylum seekers to Xinjiang; a description of U.S. diplomatic efforts to address human rights abuses in Xinjiang and to protect asylum seekers from the region and the identification of the Department of State offices responsible for leading these efforts.

A number of additional reports must also be submitted to Congress to report on issues related to the treatment of Uyghurs.  For example, within 90 days, the Director of the Federal Bureau of Investigation shall submit a report to Congress that outlines all of the efforts taken to protect U.S. citizens and residents, including Uyghurs and Chinese nationals, legally studying or working in the U.S. who have experienced harassment or intimidation within the U.S. by officials or agents of the Government of China.

Lastly, within 6 months, the Director of National Intelligence shall submit a public report to Congress outlining an assessment of the national and regional security threats posed to the U.S. by China’s policies in Xinjiang; a description of the acquisition or development of technology by China to facilitate internment and mass surveillance in Xinjiang, including technology related to predictive policing, large-scale data collection and analysis, and threats the acquisition, development and use of this technology poses to the U.S.; and a list of Chinese companies involved in the construction or operation of internment camps in Xinjiang or in providing mass surveillance technology.  The Director of National Intelligence shall also submit a classified report to Congress that assesses the ability of the U.S. to collect and analyze intelligence related to the scope and scale of detention and forced labor in Xinjiang, the gross violations of human rights perpetrated in the internment camps, and other Chinese policies in Xinjiang that constitute gross violations of human rights.

The Act comes on the heels of increased scrutiny related to the use of forced labor, both in Xinjiang and more generally.  On June 5, 2020, the Department of Commerce’s Bureau of Industry and Security (“BIS”) designated nine Chinese entities to its Entity List for their involvement in forced labor and mass surveillance in Xinjiang, prohibiting their participation in an export transaction.  And, on May 1, 2020, a Withhold Release Order was issued by Customs and Border Protection against Hetian Taida Apparel Co., Ltd. for its use of forced or prison labor in Xinjiang, prohibiting imports of its goods into the U.S.

Prior to the Act, a March 2020 report by the Congressional-Executive Committee on China outlined the difficulty of receiving reliable information about Chinese supply chains, stating that audits are not likely to be effective tools to identify forced labor in a company’s supply chains.  As a result, some suggest that the only viable solution for companies seeking to avoid sanctions by the Act is to consider the entire region of Xinjiang as “tainted” with different forms of forced labor.  Furthermore, some reports have indicated that Uyghurs and Kazakhs from Xinjiang have been relocated to other parts of China for forced labor, potentially tainting supply chains that do not touch Xinjiang.  As a result, the report recommends U.S. companies do not source materials or products from within Xinjiang or from companies that work with the government in Xinjiang.

The immediate impact of the law and the advisory is to increase visibility of the forced labor issues; some see implementation linked to the US-China trade negotiations in the short-term, but in the longer term the reports required by the law will increase pressure for designations by OFAC in addition those already made by BIS.  It is, however, also another opportunity for anyone sourcing from China to take additional steps to evaluate suppliers.  Just as KYC has become the rule for banks and exporters, “know your supplier” is increasingly carrying the same weight.

In ruling N312096 (June 22, 2020) CBP discussed a video camera from China. The EYENIMAL Pet Videocam is a small battery-operated camera that is designed to be attached to a pet’s collar.  The subject camera can record videos onto its internal memory. It is waterproof and meant for cats and small dogs. To charge or view the video content the camera is connected to a computer via a USB cable.  The camera cannot capture and record still images.

CBP determined that the applicable subheading for the subject Pet Videocam is 8525.80.5050, HTSUS, which provides for Transmission apparatus for radio-broadcasting or television, whether or not incorporating reception apparatus or sound recording or reproducing apparatus;…: Television cameras, digital cameras and video camera recorders: Other: Other.  The rate of duty will be free.

Pursuant to U.S. Note 20 to Subchapter III, Chapter 99, HTSUS, products of China classified under subheading 8525.80.5050, HTSUS, unless specifically excluded, are subject to an additional 25 percent ad valorem rate of duty.  At the time of importation, the Chapter 99 subheading, 9903.88.03, in addition to subheading 8525.80.5050, HTSUS, must be reported.

Only four months after the the United Kingdom’s Office of Financial Sanctions Implementation (OFSI) issued a £20.47 million penalty against Standard Chartered Bank (SCB) for alleged violations of the U.K.’s Ukraine- and Russia-related sanctions (see our alert here), another bank is in the news for regulatory breaches. This time it is the London arm of Commerzbank AG (Commerzbank), which was hit by the United Kingdom’s Financial Conduct Authority (FCA) on 17 June with a fine of £37.8 million ($47.4 million) for failures in its anti-money laundering controls.

The FCA is the UK’s conduct regulator for financial services firms. Financial institutions operating in the UK are required to take steps to minimise their risk of being used to facilitate money laundering or terrorist financing. These include taking reasonable care to establish and maintain an effective, risk-based anti-money laundering (AML) control framework, and to comply with applicable Money Laundering regulations.

Commerzbank is a large international, commercial bank headquartered in Frankfurt, Germany, which operates in the UK through its branch, Commerzbank London. Commerzbank London acted as a hub for sales, trading and the due diligence process for a significant number of the bank’s global customers, and was required to have in place AML policies and procedures, comprehensive and proportionate to these activities, to enable it to identify, assess, monitor and manage money laundering risk. During the period from October 2012 to September 2017, the FCA identified a number of alleged shortcomings in Commerzbank London’s financial crime controls. These included alleged failures to:

  • Conduct timely periodic due diligence on its clients, which resulted in a significant number of existing clients not being subject to timely know-your-client (KYC) checks. By 1 March 2017, 1,772 clients were overdue for updated due diligence checks. A material number of these clients were able to continue to transact with the bank’s London branch due to the implementation of an exceptions process, which was not adequately controlled or overseen and which became “out of control” by the end of 2016;
  • Address long-standing weaknesses in its automated tool for monitoring money laundering risk on transactions for clients. For example, in 2015 Commerzbank London identified that 40 high-risk countries were missing from, and 1,110 high-risk clients had not been added to, the bank’s transaction monitoring tool; and,
  • Have adequate policies and procedures in place when undertaking customer due diligence (CDD) on clients.

The FCA therefore found Commerzbank London to have breached Principle 3 of its Principles for Businesses, which requires firms to have adequate risk management systems in place. The FCA stated that these failings created “a significant risk that financial and other crime might be undetected.”

The FCA found that the failings were particularly serious because they persisted following visits by the FCA to Commerzbank London in 2012, 2015 and 2017, in which the agency specifically pointed out these weaknesses. Further, they occurred against a backdrop of heightened awareness within Commerzbank of weaknesses in its global financial crime controls following action taken against the bank by US regulators in 2015.

Commerzbank London benefitted from a 30% discount on the original penalty of £54,007,800 because it agreed to resolve the matter at an early stage. It also undertook a significant remediation exercise to address the shortcomings in its AML control framework and increased the number of employees in the Financial Crime Team in Compliance from what had been just three full-time employees in London to 42.

This penalty is the second-largest to be imposed by the FCA following the penalty it imposed on Standard Chartered Bank last year of £102 million over breaches of AML regulations.

Practical Considerations

The FCA notice provides useful reminders for financial institutions about what they are required to do in order to manage their AML risks. These include:

  1. Ensuring that they have appropriate, risk-based procedures for applying CDD measures when establishing a business relationship or carrying out a transaction for a customer;
  2. Applying CDD at other appropriate times to existing customers on a risk basis;
  3. Applying scrutiny to transactions undertaken throughout the course of their relationship with a customer;
  4. Keeping documents, data or information obtained for the purposes of applying CDD measures up-to-date;
  5. Applying, on a risk basis, enhanced customer due diligence measures (EDD) and enhanced ongoing monitoring in any situation which by its nature presents a higher risk of money laundering or terrorist financing; and
  6. Establishing and maintaining appropriate and risk-based policies and procedures relating to the above.

It will also be important for financial institutions to ensure that, if they are given warnings by the regulator about weaknesses in their AML control frameworks, they take immediate remediative action. This may include pausing new customer onboarding until such time as appropriate CDD checks can be completed; ensuring that customers’ CDD information is updated on a periodic basis according to each customer’s risk profile, and increasing the headcount of financial crime control staff and/or engaging third-party vendors to ensure that KYC and other customer diligence can be carried out timely.

Based on recent enforcement actions, regulators in the UK are beginning to police and enforce financial crime regulations more stringently and successfully. This is in line with the recent, more aggressive approach to AML enforcement taken by other EU regulators in recent years such as those in Denmark and Sweden. With the departure of the UK from the EU and following the end of the transition period on 31 December 2020, how the UK proceeds in relation to implementation of any further EU AML legislation will depend on what, if any, withdrawal agreement applies. If there is “no deal”, the UK will have to decide whether to remain aligned with the EU or not. Whatever the position on new legislation, it seems doubtful that the UK will weaken its enforcement approach.

On June 17, 2020, Team Telecom, the multiagency body that reviews certain Federal Communications Commission (FCC) licensing applications for national security and law enforcement concerns, recommended that the FCC deny the portion of the Pacific Light Cable Network (PLCN) submarine cable system application that would have established a direct connection between the U.S. and Hong Kong, citing national security concerns.  Team Telecom recommended that the FCC approve the portions of the application in so far as the undersea cable connects the U.S., Taiwan, and the Philippines, which are separately owned and controlled by subsidiaries of Google LLC and Facebook, Inc. and do not involve People’s Republic of China (PRC)-based ownership.  The recommendation that the FCC approve those portions of the application is subject to final mitigation agreements negotiated with the parties before the FCC issues an order.

In April, Team Telecom granted a six-month special temporary authority (STA) for the operation of the portion of the cable system that connected the U.S. to Taiwan, subject to terms set forth in a provisional National Security Agreement (NSA) between Google and the agencies that comprise Team Telecom, the U.S. Departments of Justice, Defense, and Homeland Security.  Among other requirements, the terms of the provisional NSA included notice obligations, access and security guarantees, and auditing and reporting duties, as well as a commitment to “pursue diversification of interconnection points in Asia.”

According to the DOJ, which chairs Team Telecom, the PLCN application raises several national security concerns, based, in part, on corporate ownership and whether information carried by the cable would be vulnerable to collection by the PRC at the Hong Kong landing station.  Team Telecom cited concerns surrounding the relationship between an investor in PLCN, Pacific Light Data Co. Ltd., a Hong Kong company and subsidiary of Dr. Peng Telecom & Media Group Co. Ltd., and PRC intelligence and security services.  Dr. Peng is the fourth largest provider of telecommunication services in China.  The Executive Branch agencies also expressed concern with the track record of Dr. Peng’s compliance with U.S. laws and regulations “stemming from separate acquisitions involving U.S. telecommunications assets” and Pacific Light Data’s connections to the Chinese state-owned telecom China Unicom, the authorizations for which the FCC is currently considering terminating.

Team Telecom’s concerns mirror many of those that formed the basis for its 2018 recommendation to deny China Mobile’s international 214 application, a license that allows for international telecommunications operations that would have enabled the company to operate in the United States, and its recent April 2020 recommendation that the FCC revoke existing authorizations for China Telecom.  Both China Mobile and China Telecom are Chinese state-owned companies.  This recommendation – like those before it – revolves around concerns that the authorizations put at risk “the sensitive data of millions of U.S. persons,” in this case through a cable system vulnerable to exploitation by the PRC.  Team Telecom expressed concerns that, if approved in full, the cable system would transit through Hong Kong before continuing on to other destinations in the Asia Pacific region, exposing large amounts of internet, data, and telecommunications traffic containing U.S. persons information to collection by the Chinese.  Recent actions by the PRC regarding Hong Kong’s autonomy have exacerbated those concerns.

Team Telecom, formally the Committee on the Assessment of Foreign Participation in the United States Telecommunications Services Sector, was recently the subject of an April 4, 2020 Executive Order that established more robust processes and procedures for the national security review body.

Takeaways for Industry

The recommendation is the latest in a series of actions that signal that Team Telecom is taking a tough stance on China projects and will oppose those transactions that involve PRC-based ownership or that present concerns regarding PRC access to sensitive data.  Currently, the existing authorizations of four Chinese state-owned companies lie in wait for an ultimate determination by the FCC as to whether they can continue to operate in the United States.  While the FCC is the ultimate arbiter of whether a company receives a license to operate, it has deferred to Team Telecom’s recommendations in the past, and is likely to do so again here.

In their recommendation, the Executive Branch agencies also noted that allowing a direct cable connection with Hong Kong would “advance the PRC government’s goal that Hong Kong be the dominant hub in the Asia Pacific region for global information and communications technology and services infrastructure.”  Team Telecom’s reluctance to approve a pathway that would almost certainly provide the PRC with such a competitive advantage is consistent with what seems to be a broader U.S. strategy to reduce the opportunities for China to wrest control from the United States and its allies over certain supply chains and reduce the PRC’s access to U.S. critical infrastructure.

DOJ stated that pending before Team Telecom are several other applications for undersea cable landing licenses that would similarly allow for a direct connection between the United States and Hong Kong.  Given the concerns surrounding a direct connection to Hong Kong identified in this recommendation, those applications – along with the large amounts of money invested and cables already installed – could ultimately meet the same fate as that of PLCN. Accordingly, the companies and investors involved in those transactions should prepare for increased scrutiny from Team Telecom and extensive and time-consuming engagement with those agencies, including responding to multiple rounds of Team Telecom’s “triage questions.”  Companies should also be prepared to discuss and consider possible mitigation strategies, which could include Team Telecom-approved third party monitors, onsite audits by U.S. government personnel, additional security protocols, and frequent reporting obligations.

As has been the case with 214 authorizations, the FCC and Team Telecom might also look anew at existing authorizations for undersea cable systems to reassess national security considerations such as those identified in this recommendation, particularly those that involve PRC-ownership or that may ultimately connect the United States to mainland China.  Companies operating under those licenses that were previously reviewed by Team Telecom might also prepare for renewed interest by the FCC and Team Telecom.  To the extent that licenses are conditioned upon mitigation agreements, companies might review their compliance with those agreements, and prepare for reinvigorated engagement with Team Telecom and the FCC.

In ruling NY N311797 (June 9, 2020) CBP discussed the classification of a zip line kit from China. The products under consideration are five models of zip line kits which are designed to enable children ages 8 years and older to ride a few feet off the ground as they are propelled by gravity to travel from the top to the bottom of the inclined cable while holding on to the freely moving pulley.  Each zip line kit consists of a seat with a rope, a heavy duty trolley with sealed ball bearing pulleys, a 5.25 steel spring braking system, and all the necessary hardware for outdoor installation.  The variations between the kits are the length of the steel cables and the maximum weight capacity allowed. 

Explanatory Note 95.06 (B) (12) states that this heading includes equipment of a kind used in children’s playgrounds (e.g. swings, slides, see-saws and giant strides).

CBP believes that the subject play equipment (namely zip line kits) are of a kind principally used in playgrounds.  It has been CBP’s position that the construction of similar items of play equipment to the ones described above are distinguishable from toys of heading 9503, HTSUS.

CBP determined the applicable subheading for the five models of zip line is 9506.99.6080, HTSUS, which provides for “Articles and equipment for general physical exercise, gymnastics, athletics, other sports…or outdoor games…; swimming pools and wading pools; parts and accessories thereof: Other: Other: Other…Other.” The rate of duty will be 4% ad valorem.

Pursuant to U.S. Note 20 to Subchapter III, Chapter 99, HTSUS, products of China classified under subheading 9506.99.6080, HTSUS, unless specifically excluded, are subject to an additional 7.5 percent  rate of duty.  At the time of importation, the Chapter 99 subheading, 9903.88.15, in addition to subheading 9506.99.6080, HTSUS, must be reported.

Crowell & Moring Monthly Webinar Series

Tuesday, June 23, 2020

12:00 – 1:30 pm EDT

In the past several years, the U.S. government has issued a series of sweeping Executive Orders, policy announcements, and other regulatory and enforcement actions as part of a multi-pronged approach to protect U.S. national interests against the perceived challenges a rising China presents.  To help industry contextualize these actions within the broader framework of the U.S. approach to China, and to understand the emerging trends, our C&M International trade professionals and C&M International Trade and Government Contracts attorneys will provide commentary and insight across a series of topics, including:

  • Recent changes to national security reviews by the Committee on Foreign Investment in the U.S. (CFIUS) targeting capital from China;
  • The new EAR foreign-direct product rule aimed at Huawei and its affiliates, and the Military End user / End Use Rule;
  • Entity List additions;
  • Tariffs and Trade Remedies developments;
  • Establishing the new Team Telecom;
  • Securing U.S. Bulk Power Systems;
  • FAR Supply Chain restrictions and implementation plans;
  • The U.S. Department of State’s announcement on the revocation of Hong Kong’s trade status; and
  • Criminal prosecution of sanctions violations and trade secret theft.

Speakers:  Andrew Blasi, Caroline Brown, Adelicia Cliffe, Stephanie Crawford, Jana-del Cerro, Chandler Leonard, David Stepp, Erik Woodhouse, and Gail Zirkelbach

Questions?

Please contact Denise Giardina for questions about this webinar series.

Transfer pricing is a major enforcement priority of China Customs in 2020. In April 2020, China Customs launched a national enforcement action to investigate and audit import transactions between related companies. More than 1000 multinational companies have received notices from China Customs requesting information on their transfer pricing policies and activities.

  1. Who will be impacted?

China Customs has initially targeted certain industries including companies in the automotive, auto parts, electronics, mechanical, and medical devices industries. China Customs may expand the scope of this enforcement action if it finds similar transfer pricing issues in other industries.

In 2016, China Customs initiated a similar national enforcement action on dutiable royalty payments by companies operating in China to overseas licensors.1 China Customs started with audits and investigations of companies in the automotive and auto parts industries, and then expanded to electronics, pharmaceutical, machinery, luxury products, and many other industries. This enforcement action lasted for more than two years. Our experience has been that companies that were prepared and organized in their responses to government inquiries associated with the enforcement action were generally able to mitigate damages and penalties.

China Customs initiated a series of reforms beginning in 2018, which included establishing three centralized Tax Collection Centers (TCCs) in Shanghai, Beijing and Guangzhou to scrutinize all import and export transactions across China. The establishment of the TCCs gives China Customs access to broader price data sources to be used to identify high-risk entries for further investigation and verification. Companies that declare a price lower than the average price for the goods across the country, based on information collected by the TCCs, are more likely to be selected by China Customs as targets for audit and investigation.

  1. Importers have the burden to disprove the influence of the relationship between importers and exporters on the import price

Consistent with the WTO Customs Valuation Agreement, China enacted customs valuation regulations that regard “transaction value” as the primary method of establishing the customs value of imported goods. An important caveat, however, is that the transaction value method applies only if the buyer and seller are not related, or if the buyer and seller are related, the relationship did not influence the import price. This is a key issue for multinational companies that send goods to their related affiliates or subsidiaries operating in China.

A related party import does not, by itself, make the transfer price unacceptable. China Customs, however, may conduct a further inquiry with the importer about a declared import price if it has reason to doubt that “the [transfer] price may have been influenced by the relationship between the importer and exporter.” (Article 44 of the Measures of the Customs of People’s Republic of China on Determination of Dutiable Value for Imported and Exported Goods). According to the PRC Customs Audit Regulations, China Customs is entitled to carry out an audit on the acceptability of declared import prices within three years from the date of release by Customs of the goods. (Article 2 of the PRC Customs Audit Regulations).

If China Customs challenges an importer’s declared transfer price, the importer has the burden to prove that such price has not been influenced by the relationship between the importer and its related multinational exporter and therefore constitutes an acceptable basis for China Customs valuation purposes. (Article 17 and Article 18 of the Measures of the Customs of People’s Republic of China on Determination of Dutiable Value for Imported and Exported Goods). Generally, the importer may disprove the influence of the relationship in the following two ways:

  1. The transfer price closely approximates one of the “test values” including the transaction value of identical or similar goods, the deductive value and computed value for identical or similar goods. The test provides importers an opportunity to demonstrate that the transfer price closely approximates a value that has been previously accepted by China Customs and is therefore acceptable for China Customs valuation purposes; or
  2. The transfer price satisfies the “circumstances of the sale test.” No further guidance is provided on the application of the test under China Customs’ valuation regulations. Based on our experience, the test is satisfied if (1) the price is settled in a manner consistent with the normal pricing practices of the industry in question; (2) the price is settled in a manner consistent with the way the exporter settles prices for sales to unrelated buyers; or, (3) the price is adequate to ensure recovery of all costs plus a profit that is equivalent to the exporter’s overall profit realized over a representative period of time in sales of goods of the same class or kind.

On its face, the circumstance of sales test in China is consistent with the standards set forth in the World Trade Organization Valuation Code and the U.S. valuation laws and regulations. However, Chinese importers should seek expert guidance if their transfer prices are questioned because China Customs’ actual practice in analyzing the arm’s length nature of transactions may differ from U.S. and EU customs authorities.

  1. Importers that fail to disprove the influence of the relationship between related parties may be subject to additional duty liabilities and/or penalties

If an importer fails to prove that a transfer price between related parties has not been influenced by the relationship between the importer and exporter, China Customs may reject the transfer price declared by the importer and re-appraise the customs value of the goods with another alternative method. This generally results in a higher appraised value and assessment of additional import taxes. More importantly, a change in valuation is not just a one-time event for previous transactions; the new valuation method determined by China Customs will also be used for future imports.

Before 2016, the primary China transfer pricing Customs risk was reassessment of the subject goods to a higher price. China Customs rarely assessed any penalties on an importer unless there was evidence of intentional misconduct. In 2016, however, China Customs amended its Import and Export Declaration Guidelines by requiring importers to fill in the corresponding columns in the declaration form with a simple “Yes” or “No” answer to confirm the existence of affiliated relationship between the importer and exporter and the influence of such relationship on the import price. If China Customs finds the declaration to be inconsistent with facts discovered in an audit or investigation, China Customs may impose administrative or criminal penalties on the importer.

  1. Now is the time to prepare for potential transfer pricing customs audits or investigations

In the light of the increased China Customs transfer pricing enforcement risk, multinational companies who frequently import goods and components into China from their affiliated companies operating outside of China should review their intercompany import prices and prepare for a China Customs audit or investigation.

Below are defensive strategies that multinationals should consider in anticipation of a China Customs audit or investigation.

First, prepare arguments based on China Customs’ valuation rules. China Customs valuation rules are separate and distinct from the transfer pricing rules applied for income tax purposes. The fact that a transfer price is acceptable to the income tax authorities (China State Administration of Taxation) does not necessarily mean it is also acceptable to China Customs2. In practice, many multinationals rely on their transfer pricing studies and/or contemporaneous documents prepared for income tax purposes to justify their import price to the customs authorities. Although China Customs regularly requests transfer pricing studies and contemporaneous documents as part of its investigations and audits, such studies can be insufficient or even damaging to the importer. For example, information in transfer pricing studies3 can be used against the multinational companies by China Customs. Some companies use such studies to set their profit margin in the upper quantile range of prices used by comparable companies to establish a benchmark of “arm’s-length” pricing for products sold between related companies. From a China Customs perspective, however, this could be interpreted as prima facie evidence that the price has been influenced by the relationship between the importer and exporter. As such, it is important for multinationals to address the inherent tension between China Customs and income tax authorities related to transfer pricing and make sure your arguments are based China’s customs valuation rules.

Second, in China, it is important to understand common practices and work effectively with China Customs. When China Customs considers using an alternative valuation method to establish the dutiable value, it should properly consult with the importer. Having the ability to understand and negotiate with China Customs about their proposed approaches should be based on recent trends and China Customs practices. Of course, such consultations should always be conducted in a manner consistent with corporate compliance policies.

Third, multinational companies should carefully assess and manage the risks of escalation of the customs audit or investigation. The scope of a China Customs audit or investigation is not static and restricted by administrative law. China Customs may expand the audit or investigation to other products or entities of your company at any time in the course of the ongoing process. China Customs may also transfer the case to the China Anti-Smuggling Bureau for further administrative or criminal investigation if any noncompliance or violations are identified. Companies should carefully manage the risks of escalation and consider voluntary self-disclosures where necessary.

It is important to note that the decision to make a voluntary disclosure to Chinese authorities is complex and is significantly different from considerations involved in making a voluntary disclosure to U.S. authorities.

Fourth, multinational companies should be careful when making transfer pricing adjustments as a result of the COVID-19 pandemic and/or U.S.-China trade war. Multinational companies may find themselves making new and larger-than-usual transfer pricing adjustments to reflect the impact of the COVID-19 pandemic and/or the increased tariff costs as a result of the U.S.-China trade war. Typically, these adjustments are made to bring transfer prices within arm’s length ranges for tax purposes. We recommend that companies review these adjustments to make sure they are also consistent with China Customs’ valuation regulations.

Please contact us with any questions.

The Bureau of Industry and Security (BIS) published a final rule in the Federal Register effective June 17, 2020, amending the Export Administration Regulations (EAR) to implement the decisions made at the February 2020 Australia Group Intersessional Implementation Meeting, and those subsequently  adopted pursuant to the group’s procedures.

The Australia Group is a multilateral forum consisting of 42 participating countries and the European Union that maintain export controls on a list of chemicals, biological agents, and related equipment and technology that could be used in a chemical or biological weapons program.

Specifically, this rule amends the following Export Control Classification Numbers (ECCNs) to reflect the AG changes:

  • ECCN 1C350 is amended by adding 24 precursor chemicals, as well as mixtures in which at least one of these chemicals constitutes 30 percent or more of the weight of the mixture, to ECCN 1C350.d.
  • ECCN 1C351 is amended to add Middle East respiratory syndrome-related coronavirus (MERS related coronavirus).
  • ECCN 2B352 is amended by adding a Technical Note to indicate that cultivation chamber holding devices controlled in 2B352.b.2.b include single-use cultivation chambers with rigid walls.

The items addressed by this final rule were not previously listed on the CCL or controlled multilaterally. BIS’ notice states that it identified the items now controlled pursuant to this change as emerging technologies that are essential to U.S. national security and for which effective controls can be implemented, “consistent with the inter agency process described in Section 1758 of the Export Control Reform Act of 2018 (ECRA).”  BIS did not, however, provide a notice and comment period prior to issuing this final rule, as required under the Section 1758 ECRA process for identifying emerging technologies for control.  As a result, it remains unclear whether the items now controlled as a result of this final rule constitute “emerging and foundational technologies controlled under Section 1758” for purposes of the Committee on Foreign Investment (CFIUS) definition of  “critical technologies,” under 31 C.F.R. § 800.215(f).  In any event, the newly controlled technologies now meet the second prong of that definition because they are controlled on the Commerce Control List pursuant to a multilateral regime (the Australia Group).