How A Handful of Bolts Cost A Billion Dollars

Last week, the Court of Appeals for the Federal Circuit forced Ford Motor Company to take, as a colleague aptly described it, a complete “U-Turn” in its strategy to not pay the so-called Chicken Tax on imported Transit Connect vehicles.  While this case has generated interest as an example of the lengths importers will go to avoid paying high tariffs, the point of this blog post is to highlight the importance of paying attention and respect to the facts and details of importing goods – about how a handful of bolts could determine whether or not Ford has to pay a billion dollars in order to do its business of selling cars and trucks.

The Chicken Tax, a 25% tariff on imported trucks and other cargo carrying vehicles, is a vestige of a trade war between the USA and Germany back in the 1960’s.  This hefty tax on trucks contrasts sharply with the tariff on passenger cars which is only 2.50%.  The Ford Transit Connect is a dual use vehicle produced in two configurations:  as a passenger wagon and a cargo van.  The challenge for Ford was to import Transit Connects that could be sold in the configuration chosen by the customer: wagon or van, but pay only the lower 2.50% passenger car tariff.

Ford’s strategy was to “ship and import cars; convert to cargo van after cleared by Customs”.  To execute this duty savings strategy, Ford shipped all Transit Connect vehicles from its plant in Turkey into several US ports in a passenger car configuration: two rows of seats and seat belts for four or five passengers, sliding side-door access to the 2nd row seats, side window glass, and a foot well in front of the 2nd row seats for passenger comfort.  Ford declared all of these vehicles to U.S. Customs as passenger cars and paid the 2.50% duty rate. 

After Customs clearance, most, but not all, of the vehicles were converted to cargo van configuration.  The 2nd row of seats were removed, side-door glass was replaced with metal panels, and the footwell was filled in with a metal insert to level the floor.  Ford marketed and sold those Transit Connects as cargo-carrying delivery or work vans.

The legal issue in the case was which tariff provision should be applied to Ford’s Transit Connects? Tariff schedules are compilations of brief descriptions of things designed to capture anything and everything that can be imported from another country.  Each description is assigned a code number and each code number is assigned a tariff rate (%) applied to the imported goods.  In Ford’s case, the choice was between vehicles “designed principally for carrying passengers”, tariff code 8703 at 2.50% tariff rate or vehicles with the “principal purpose of carrying cargo”, tariff code 8704 at 25%, the Chicken Tax.

Tariff classification, the process of determining which tariff provision should be applied to imported goods is notoriously subjective; it is far more an art than a science.  For the Transit Connects, the Court had to decide whether the car provision, 8703, should be read, as Ford contended, as one that describes the physical nature:  structure, features, etc. of the vehicle or as Customs argued, one that depended on the ultimate use of the vehicle and the importer’s (Ford’s) intentions for the vehicles, more or less regardless of what was actually imported.  The Federal Circuit chose intended use over actual physical condition; although explaining the opinion’s rationale and logic in how it came to that conclusion requires words with Greek and Latin roots, like “exegesis” and “evolution”, and maybe “judicial activism”.

The Federal Circuit’s opinion is fatally flawed because it rests on a critical misapprehension about the permanence of the 2nd row seat.  Notes to heading 8703 state that “passenger vehicles must have permanent seats with safety equipment … for each person or … permanent anchor points and fittings for installing seats and safety equipment in the rear area …”.  Customs contended that because the Transit Connect 2nd row seats were removed by one person using a battery powered hand tool in less than a minute, they could not possibly be considered permanent.  The Court agreed.  The Court found that the mere removal of the 2nd row meant the seat was designed to be temporary and, therefore, the converted Transit Connects had not been designed as passenger cars, ergo they were trucks.

The factual record in this case, on which the Federal Circuit relied, establishes that the 2nd row seats in the converted Transit Connects were secured to the vehicle floor in exactly the same way as the 2nd row seats in the passenger Transit Connects, which Customs agrees are passenger cars:  they were bolted to the anchor points in the vehicle floor.   Bolting permanently secures the seats to the vehicle.  Bolting is the way the automotive industry universally installs seats in motor vehicles. 

Permanence in this aspect of motor vehicle assembly has to be understood in context of protecting the vehicle’s passengers.  Do all seats and safety restraints have sufficient structural integrity, strength and overall crashworthiness to protect the occupants of a vehicle to applicable safety standards?  The court found that prior to conversion, the Transit Connects at issue were “street legal”, meaning that they could be driven on streets and highways just as safely as the passenger Transit Connects or any other passenger vehicle.

Thus, the Federal Circuit’s entire decision hinges on the clearly erroneous factual conclusion that the 2nd row seats in the converted Transit Connects were designed to be temporary, not permanent, because, and only because, they were ‘easily’ removed by a hand tool.  But, in the design and assembly of a machine, that isn’t what permanence means.  All parts of motor vehicles can be removed; that characteristic doesn’t make any of those parts temporary or not permanent.  A key event in the Industrial Revolution was the invention of interchangeable parts . The ability to remove a part for repair, maintenance, or replacement is a feature of almost every manufactured product.  But for the finding that the removal of the 2nd row seats meant that the converted Transit Connects were not designed to have permanent 2nd row seating, the Federal Circuit’s decision has no foundation. 

Like those of us who have gotten lost while driving in unfamiliar territory, having made one U-Turn and heading in the wrong direction, it is for the Federal Circuit in reconsideration or for the Supreme Court to correct this error by making another U-Turn and heading Ford in the right direction. 

Even if Ford is unsuccessful in further appeal, this issue won’t go away.  FCA’s Chrysler has been importing the Ram ProMaster City for more than five years now and doing exactly the same post-importation conversion that Ford has done for exactly the same reason: to avoid the 25% Chicken Tax on cargo vehicles.  The 2nd row seats in ProMaster City are undoubtedly secured to the vehicle floor by bolts.  Now will Chrysler’s plan come unbolted too?

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NAFTA IS Dead; Long Live the USMCA!

Borrowing liberally from Shakespeare, I come not to praise NAFTA, but to bury it. NAFTA is the most comprehensive and successful trade agreement ever, if only because it saved the North American auto industry by rationalizing production of vehicles and parts throughout the North American region. Yet throughout its entire history, NAFTA has been known as “a giant sucking sound” and the “worst deal ever”, the destroyer of jobs and communities. Like a scarlet letter, NAFTA’s reputation with the general public has been as a pernicious and inerasable stain blotting out the many benefits NAFTA has bestowed.

Why the disconnect? What caused NAFTA’s epic failure to capture the approval of American Main Street? The answer lies in NAFTA’s weedy details, the process by which goods are certified as qualifying for NAFTA duty-free benefits: the rules of origin.

Rules of origin are critical to the workings of any trade agreement but, by their very nature, they are both complex and arcane. And for reasons no longer relevant or applicable, NAFTA’s origin rules are devilishly so. To know whether something qualifies for NAFTA, its rules of origin require only what does not qualify to be counted. That’s right; NAFTA’s origin rules require that to show what is needed, only what isn’t needed is reported! So, when a certificate of origin shows that a car has the required 62.5% of NAFTA content, what’s actually documented is that the car has no more than 37.5% of non-qualifying content. Even those numbers are questionable, however, because of a rule, specific to the auto sector, called “tracing”, which allows some content, such as nuts and bolts from China, to be “deemed originating”, while other truly qualifying content, like door assemblies and instrument panels made in the same plant as the finished vehicle, cannot be counted as NAFTA content.

That’s how NAFTA works. NAFTA’s origin rules with their negative focus have all but obliterated the proof of NAFTA’s tremendous good. Seemingly impenetrable to 24+ years of economists building models to tell NAFTA’s story, its origin rules work to hide the many and varied jobs and other economic contributions involved in making a car or pickup: from hourly factory workers to highly skilled engineers, not to mention those who make the equipment and tools used in the assembly plants or the truckdrivers or railroad personnel that move everything from here to there. All these contributions and others, such as the value of the R&D that occurs within NAFTA, the billions in investment, and the positive effect all these contributions have on the towns and communities where they happen are neither counted nor recognized because the NAFTA origin rules expressly exclude them. The result has been much like that of effective negative political ads: we have no idea of NAFTA’s positive economic impact or how it could be improved, all we see is a dark cloud of loss and uncertainty.

The new trade agreement replacing NAFTA, awkwardly dubbed the USMCA, goes a long way to fix NAFTA’s near-fatal flaws by taking a new tack on the rules of origin. Focusing on the positive, the new origin rules count all the content that makes a product qualify, instead of what doesn’t. By counting up, not down, more of the economic contributions (jobs, investment, capital equipment) from North American manufacturers will be visible to the public. At last, contributions from the three-person gasket maker to the plant worker who installs the grille on a brand-new car with a few truck drivers in-between will be recognized.

Yet, the reaction to the new NAFTA from those who have been making the old NAFTA work, the automakers and parts suppliers, has been wary and critical. Understandably. The new agreement significantly increases the required content percentages: cars and pick-ups will need 70% qualifying content, up from 62.5%; while the threshold for some parts jumps all the way to 75%. And there are more reporting requirements, such as showing those manufacturers who pay their workers $16 an hour or more and that at least 70% of the steel and aluminum comes from North American mills. The cost and complexity of the new origin rules, the auto industry fears, will cancel out any improvements in the new agreement,

But, has the auto industry and other USMCA critics missed the silver lining? By turning the effort and emphasis to documenting what is in and not what is out, the new agreement’s rules will reveal contributions that have been there all along and establish a more intuitive qualification process with inputs from more contributors. Since a great many parts suppliers are located in the U.S. and Canada, where high wages are prevalent, and the auto industry already sources more than 95% of its steel and aluminum requirements from U.S. and Canadian mills, those reporting requirements shouldn’t be too difficult.

Qualifying goods for USMCA will be a snowball process: starting at the top, each producer will show its contribution and then pass that down to the next one, who will add their contribution and pass it along. Add in some manufacturing processes NAFTA currently prohibits: “intermediate goods”, those door assemblies and instrument panels made in the same plant as the vehicles, and “roll-up”, which in transforming parts and materials into something new and different is the essence of manufacturing; we all may well find the new origin rules to be more attainable than NAFTA’s, not less.

The reformed origin rules alone call for the auto industry’s strong support for the entire USMCA. Congress should approve it. Bringing to light the positive contributions from North American producers will allow at last the American public the chance to understand, and maybe even celebrate, international trade rather than flinch from and scorn it.


Tackling Trump’s tariffs

From farmers to auto makers, American business is feeling the jabs of Trump’s trade policy and many are wondering how they might soften, if not duck entirely, the pain Trump’s tariffs are inflicting.

Held up like an archeological find is Ford Motor Co.’s ongoing effort to ‘outfox’ the so-called Chicken Tax, a relic of a 1960’s trade war between the U.S. and Germany over American chicken parts exported to Europe, the last vestige of which is a 25 percent tariff duty on trucks imported to the United States. Since late 2009, Ford has been importing the Transit Connect, often seen on the streets as a small delivery or service truck, from its factories in Europe. Ford imports this vehicle as a passenger car, which attracts a 2.5 percent tariff. After Customs clearance, many, but not all, are converted into trucks, which if imported as such would be subject to the 25 percent Chicken Tax.

As Ford’s in-house trade counsel from 2000 to 2017, I advised Ford how it could legally import the vehicles without paying the 10 times higher duty. Ford’s imported Transit Connect program is instructive in showing importers some options to avoid falling victim to high tariffs, but, perhaps more important, that there is no easy, one-size-fits-all solution.

A successful trade strategy has three elements: a well-defined business need, an appropriately scoped and scaled solution, and a commitment from the entire organization to both flawless execution of strategy and then being prepared to explain and defend the strategy, if questioned or challenged. For a trade strategy to be truly successful, all elements are required and must be applied in order.

Around 2006, Ford identified a “white space” in the U.S. commercial vehicle market for a small, fuel-efficient delivery truck, meaning there was consumer demand but no supply. Because projected sales volume was relatively low, manufacturing in North America was ruled out. Not coincidentally, the Transit Connect was already in production in Europe.

Ford realized that it could save hefty design and developments costs and be first into the new segment, but only if they could figure out a way to import the truck without having to pay the 25 percent Chicken Tax. Despite its historical origins as a temporary retaliatory tariff, the official U.S. tariff on imported trucks has been 25 percent for more than 50 years and only Congress has the power to change it. This strong and clearly articulated business case coupled with the Chicken Tax’s permanence justified creative thinking about a possible trade solution.

Second, the trade strategy should be of a scale and scope commensurate to the trade problem. Ford spent more time and resources in designing and implementing the U.S. portside conversion process than it did adapting the European-made Transit Connect for North America. Establishing sufficient manufacturing capacity in Europe to support both European and North American markets for the vehicle and establishing a supply chain that included the U.S. portside post-Customs clearance wagon-to-van conversion process were relatively long-term commitments, the scale and scope of which were appropriate to the problem of overcoming the 25 percent Chicken Tax.

Finally, Ford committed resources and personnel from all parts of the company to support and ultimately defend the Transit Connect program. While my legal trade advice provided critical direction to avoid the Chicken Tax, it was the execution of that direction primarily by Ford’s product and process engineering teams that made the Transit Connect program so legally sound and strong. Without the care and skill from Ford’s engineers and operations personnel, the trade strategy I laid out may well have been disastrous for Ford.

Even though the amounts of Trump’s tariffs are the same as the Chicken Tax, they are not the same trade problem and, therefore, overcoming Trump’s tariffs will require very different trade solutions. The key difference is the timeframes. Having been around for more than 50 years, the Chicken Tax is effectively permanent. Trump’s tariffs are recent, highly volatile and not likely to stay in place for very long.

The approach, however, to solving the Trump Tariff problem should be exactly the same as Ford took with its Chicken Tax solution.

Identify the business need. Wanting to avoid payment of higher tariffs is not necessarily a business need. How dependent is the business for those products from a particular country? Can the additional costs be reasonably absorbed or passed on to customers?

Establish the appropriate scale and scope of the trade solution. Because Trump’s tariffs are likely to be relatively short-term, any solution should be scaled so that it can be quickly implemented and then undone or switched to another trade flow just as quickly.

Finally, the chosen trade solution must have complete commitment from the entire enterprise; it cannot be a desk exercise for the Customs manager and logistics team. Making the trade solution part of the business, supported by all areas, validates it.

While a solution to Trump’s tariffs may be short-term, the business must recognize that the consequences of actions taken may be long-term and the business must be prepared to explain and defend the action whenever the question comes up. The Transit Connect first came to the U.S. in late 2009; Customs claims it didn’t become aware of potential issues until early 2012; and now in 2018, the case is still being fought in the courts.

Successful trade strategies employ out-of-the-box thinking to create entirely in-the-box solutions. Ford’s Transit Connect strategy is a useful case study that shows how business can avoid becoming collateral damage to aggressive, hurtful trade policy.


The Definition of Tariffs: Let’s Get This Right

The weapon of choice for the Trump Administration’s multi-front war on international trade is tariffs on certain goods produced by U.S.A. trade partner countries that the President claims have cost American jobs or, even, implausibly, threaten America’s national security. The words used in international trade are, to say the least, unfamiliar to the general public; some of them are arcane even to veteran trade practitioners. The term “tariff” is one of them.

To help their audience, the media covering the moment-to-moment drama of Trump’s trade wars have attempted to provide a definition of tariff. Most get it mostly right, but in these times of misinformation and lack of clarity and specificity, intentional or innocent, it is essential to get the definitions of trade terms, such as “tariff”, exactly right. Unless those affected or even potentially affected by international trade (and there seem to be very few anywhere who aren’t) have a clear, precise understanding of the words being used, they will not know how to react appropriately.

For example, a video published by Canada’s Globe and Mail, in connection with their otherwise excellent and comprehensive coverage of the NAFTA renegotiations and the increasing friction in trade and political relations between Canada and the USA (See “Risk of Trade War Continues to Rise”), correctly said that tariffs are fees, similar to taxes, imposed by a government on goods produced in a foreign country, but incorrectly said that those tariffs were paid by the foreign producer. Tariffs, also known as import or Customs duties, are paid by the importer, usually the purchaser, of the foreign goods when those goods arrive in the importing country; they are not paid or payable by the foreign producer. (In fact, at least in the USA, it is illegal for a foreign producer to reimburse its importer-customer for certain types of tariffs, such as Anti-Dumping and Countervailing Duties.)

Who will actually and literally pay the price of the tariffs Trump has imposed or threatened to impose apparently has not been widely understood. For example, in a recent op-ed in Crain’s Detroit Business, the CEO of Lucerne International expressed surprise and alarm that the tariffs “her” President wanted to impose on Chinese metal products (comprising the entirety of her product line sold in the US) would be paid by her company, adding an uncompetitive and potentially crippling cost.

So, let’s be clear: tariffs are essentially taxes imposed by the government of an importing country on foreign goods. Tariffs are paid by the importer of those goods, not by the foreign producer or the foreign government. Even if the purpose of the tariffs is to change the conduct or policies of the foreign producer or government, that change will only be affected by the changed behavior of the importer or the importer’s customers, assuming that the importer or the ultimate consumers can or want to change their purchases of the target foreign goods.