Companies deciding whether to export products from China must carefully weigh immediate and long-term profit potential against the costs of shipping and entering their products into foreign markets. The most important considerations are whether the laws of China and the foreign country allow the products to be traded and, if so, whether licenses must be obtained. Next, companies will need to know whether the products are subject to target country import duties and, if so, the amount of such duties. One of the necessary first steps to understanding these issues is classifying products under the export and target countries’ product coding systems based on the Harmonized System (“HS”).
By way of background, the Harmonized Commodity Description and Coding System, referenced as the Harmonized System or “HS,” was developed by the World Customs Organization. The HS allows for standardized classification of goods to six digits. Over 200 countries use HS codes for different purposes, one of the most important of which is import tariff determinations.
For anyone who exports or will export products from China to the United States, such products must be classified under the U.S. Harmonized Tariff Schedule (“HTSUS”). One way to think about the HTSUS is to compare it to the Plinko game featured on the daytime television game show The Price Is Right. In the game, contestants drop chips onto a vertically sloped Plinko board and wait to see into which slot the chip falls, with different slots representing different amounts of money that the contestant may win. Like a Plinko chip that must fall into one of the board slots, a product imported into the United States must fit into one of the HTSUS classifications. Also, just as the Plinko chip’s fall determines how much cash a contestant will win, an HTSUS classification will determine whether an import duty applies to the product and, if so, how much.
The HTSUS is divided into different general sections, such as Section VII “Plastics and Articles Thereof; Rubber and Articles Thereof,” and 99 chapters, such as Chapter 39 of Section VII “Plastics and Articles Thereof.” Classifying goods under one of these HTSUS sections and chapters follows the General Rules of Interpretation detailed in the HTSUS. Though section and chapter headings may assist in determining the appropriate classification, exporters and importers must carefully review the terms of the headings and notes to determine correct classifications.
The General Rules govern how products are classified and provide a prioritized hierarchy for doing so. For example, the General Rules specifically state that references to products include unfinished versions of such products if the unfinished products share the finished product’s “essential character.” Similarly, the General Rules detail how to determine appropriate HTSUS classifications if goods can be classified under more than one category.
Regardless of where a product will be exported, exporters in China should undertake the necessary efforts and involve the appropriate company employees to determine a product’s HS classification. Classifying goods can quickly turn into a very technical exercise – especially when the goods at issue are electronic goods or contain many subcomponents or parts. Often, companies’ R&D or manufacturing departments need to be involved in the classification process to ensure products’ composition and uses are correctly understood.
Importantly, companies should dedicate the time and resources needed to correctly classify a product early in the process of evaluating export options.
Because import tariffs normally depend on assigned HS classifications, misclassifications can result in one of two unwelcome scenarios. Under one scenario, a company can incorrectly classify a product under an HS category that has a corresponding import duty that is higher than the HS category under which the product should have been categorized. Under a second scenario, a company can incorrectly classify a product in an HS category that has a lower import duty than the category into which it should have been categorized. As described below, both scenarios can have adverse consequences.
Under both scenarios, HS misclassifications can result in unnecessary costs and reputational damage. Unnecessarily paying higher import duties adversely impacts exports’ profitability and may even impact a company’s decision to enter an export market. On the other hand, failing to undertake the necessary due diligence to correctly classify a product under the HS can result in fines and penalties if an importing country’s Customs agency audits an HS determination. In addition to incurring Customs violations and penalties, importers can suffer reputational losses with the Customs agency that may result in future delays in importing goods in the future – yet another adverse indirect importing cost.
Companies that are doing business in China and looking to export their goods from China must carefully evaluate a target country’s legal system and import regime and the associated costs for importing into the particular country. Classifying a product under the HS – or HTSUS for the United States – is a fundamental requirement that will inform these decisions. However, care should be taken to ensure the HS classification numbers are correctly determined and documented at the outset. Second chances and revisions may prove costly.