Stricter Customs Audits Coming Back Into Fashion

8/7/2013
To the average consumer, it seems that fashion trends come and go with the wind. But industry experts know there is a cyclical nature to what is “in” and what’s considered “out.” The political and economic climates of the times play a role, as does the desire to take what has worked before and make it work again, but always with a trend-setting twist.

Customs & Border Protection’s Regulatory Audit Division may be following a similar pattern by bringing back the traditional “gotcha” import audit reminiscent of the 1980s and early 1990s. The twist? It seems that this new trend may include more of a focus on small- and mid-sized enterprises (SMEs).
According to Sandler, Travis & Rosenberg sources, while all importers are cautioned to prepare for what is expected to be another wave of intense government scrutiny, the textile and apparel industry should be on heightened alert.

High duty means high risk
Textiles and apparel have some of the highest duty rates of all imported products and are responsible for more than $8 billion a year in duty revenues. Free trade agreements, preference programs and other methods for lowering this tariff burden are thus extremely attractive, and more than $17 billion in textiles and apparel imports receive such duty benefits every year. But less scrupulous actors are constantly fashioning schemes to take advantage of these lower costs without complying with the applicable rules, which could make a significant dent in Customs revenue. Small wonder, then, that the textile and apparel industry is usually the first to feel the weight of Customs’ enforcement and audit actions.

Brief history of customs audits
Two decades ago, the majority of Customs’ audit work came from referrals. Perhaps an official from the local field operations or enforcement office identified a known or perceived problem with an importer, or a disgruntled employee blew the whistle on his company. There was a widespread “gotcha” mentality that put a premium on using audits to identify bad actors and assess harsh penalties.

Things changed for the better after implementation of the Customs Modernization Act of 1993, which brought about a fundamental change in the way the import community interacts with Customs. Compliance was now a shared responsibility between Customs and importers: Customs made more of an effort to educate importers about compliance issues, and importers agreed to exercise reasonable care in conducting import transactions and to maintain adequate records to support their decisions.

Customs adopted a risk-based approach to selecting importers for audits that involved analysis of nearly 30 import attributes and characteristics. Importing apparel products put a company at high risk for noncompliance. If the company used preference programs, its risk score went even higher. Even under this kinder and gentler compliance-oriented climate, textile and apparel companies were likely to be placed on the government’s compliance assessment audit list. Once the review was complete, Customs determined the extent of any noncompliance, estimated the total amount of revenue due, and designated the importer as low, moderate or high risk, which had a direct impact on the number of inspections and compliance exams the importer received at ports nationwide.

Within just a few years, however, importer concerns prompted Customs to replace compliance assessments with focused assessments (FAs), which are designed to be less intrusive and to instead emphasize assessments of risk based on evaluations of internal controls. Customs can engage in more extensive compliance testing if an FA reveals an unacceptable risk. Customs can also shift the burden to the importer by requiring it to develop a compliance improvement plan, which is focused on the areas of noncompliance and which sets forth ways to strengthen internal controls accordingly. The FA process generally encourages importers to take a more active role in identifying and remedying problems, including filing prior disclosures.

But old habits die hard, and Customs ended up adding another tool, the quick response audit (QRA), that often involves significantly more testing and sampling to hone in on a particular objective or risk area. QRAs are always the result of a referral to address a perceived or known problem and are less about internal controls and more about uncovering specific evidence of noncompliance. As a result, QRA auditors tend to exhibit less flexibility and recommend more enforcement actions as may be deemed appropriate by Customs under the circumstances.

Back to the future
Government budget cuts are making a more effective use of resources a higher priority. With fewer auditors in the field, it makes sense that Customs focuses more on traditional audits that uncover violations and produce revenue from penalties and back duty payments rather than on helping importers strengthen their internal controls.

But the new traditional audit has a twist, because this time around SMEs may be more frequent targets. The reason is simply that Customs tends to know less about these companies. A majority of the largest importers have become well known to Customs through the FA program as having implemented systems and controls to manage their risks. These same companies tend to be participants in the Customs-Trade Partnership Against Terrorism and, to a lesser extent, the Importer Self-Assessment program, which gives Customs additional visibility into their operations. Customs has also created 10 Centers of Excellence and Expertise around the country (including one for apparel, footwear and textiles in San Francisco) to increase agency knowledge of assigned industries, facilitate “trusted trade” and improve enforcement focus on industry risk imports.

It would therefore be a logical step for Customs to resume a more hands-on approach to auditing for small and medium-sized importers. For example, the agency may look to streamline its internal control surveys for these companies to identify areas of risk and then do its own testing and sampling early in the audit process to determine the extent of any noncompliance and to calculate any monies owed. The identification of specific problems could also yield an increase in the use of QRAs, with more enforcement actions taken in support of audits.

Preparing for an audit
Audits can be a major headache for any importer, which is why proper preparation is key. First, importers will want to assess their compliance risks and determine whether a renewed focus by Customs on auditing could put them in the hot seat. Textile and apparel companies are considered high risk due to the high-duty rates of the merchandise they import. Add to that the complexities of apparel classification, the multi-level supply chains that make up most apparel production, and the challenges of maintaining all the records needed to prove entry claims, and the industry’s risk level climbs. Now, factor in the use of one or more FTAs or preference programs and it’s easy to understand how even small- and mid-sized importers could be targeted for audit.

Next, at-risk importers are advised to undergo a mock customs audit to pinpoint weak areas and bring operations into compliance before the government starts making inquiries. If your company has been receiving an increased number of information requests or other communications from Customs, it is strongly recommended that you undergo a simulated customs audit as soon as possible. Even if your company is not currently under scrutiny, if it engages in high-risk activities — and importing apparel is, by definition, a high-risk activity — you are advised to undergo some level of import operations review. You may want to consider engaging legal counsel to conduct the review, rendering your internal results subject to the attorney-client privilege. Customs counsel can also advise you regarding whether taking corrective action such as filing a prior disclosure of violations is warranted. Developing written compliance procedures and seeing that your in-house import staff is properly trained in compliance matters are also key to surviving a customs audit. Even if you pass your audit with flying colors you will need to show that you have the skills and tools necessary to remain a compliant importer.

TOM TRAVIS is managing partner of Sandler, Travis & Rosenberg, P.A., a leading customs and international trade law firm. He also serves as chairman of ST&R’s related consulting company, Sandler & Travis Trade Advisory Services. With 12 offices in six countries throughout North America, South America, Asia and Europe, ST&R and STTAS form the largest customs and international trade services provider in the world. Our strengths lie in the experience and creative problem-solving skills of the more than 600 hard-working global trade professionals who make up our team.

ST&R produces the Sandler, Travis & Rosenberg Trade Report, a free newsletter read by thousands of international trade professionals each day. Visit www.strtrade.com/publications to subscribe, review the current issue and search ST&R Trade Report archives.

To reach Tom Travis directly, email him at [email protected] or by telephone: 305.894.1001.





Should your company undertake a mock customs audit?

If you can answer “yes” to any of these questions, then you should seriously consider undergoing a mock customs compliance review.
• Have you seen an increase in Customs communications, e.g., CF-28s and/or CF-29s?
• Have you filed Post Entry Amendments (PEAs) and/or a prior disclosure with Customs?
• Do you engage in related party transactions (transfer pricing)?
• Do you submit end-of-year price adjustments to Customs?
• Do you plan to participate in a Customs partnership program such as ISA or C-TPAT, or become a member of a Center of Excellence and Expertise (CEE)?
• Do you import items under a preferential or free trade program (FTA) such as NAFTA, GSP, DR-CAFTA, etc.?
• Do you import items recognized under a CBP Priority Trade Initiative such as textiles & apparel, footwear, agriculture, or trademarked/copyrighted merchandise?
• Do you import products under recent Congressional scrutiny such as children’s clothing or other items involving import safety?
• Have you recently purchased or are you contemplating the purchase of a new business unit?
• Have you experienced a significant change in your import processes/supply chains in the past two years, e.g., opened or engaged new factories overseas, imported new items, change in country of manufacture or export, change in customs broker?
• Do you participate or plan to participate in first sale duty savings?
• Do you count government compliance among your core values and include it as an important component of your Code of Conduct?

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