Tariff Pressure Builds on Valve Industry

In the last year, one word has dominated U.S. trade policy: tariffs. From the Trump Administration’s steel and aluminum tariffs to tariffs on half of the products imported into the U.S. from China to the retaliatory tariffs from a half-dozen governments, few industries have been spared.

The valve industry is no exception. While the U.S. tariffs on Chinese valve products under Section 301 are the main subject of this article, also important to U.S. valve makers is implementation in the U.S. of global Section 232 tariffs on major valve industry inputs (e.g., 25% tariffs on steel and 10% tariffs on aluminum). Some product and country exemptions from those tariffs have occurred, but these measures have placed significant price pressure on industry inputs. Other countries have also retaliated against U.S. products in response to Section 232 steel and aluminum tariffs (e.g., Turkey’s tariffs against certain centrifugal pumps). There currently is no end in sight to the effects of Section 232 tariffs.

Section 301

In addition to Section 232, the U.S. has implemented tariffs on a wide variety of Chinese products of specific concern to the valve industry under the Administration’s Section 301 action against China’s intellectual property violations. Currently, more than two dozen valve products either imported from or exported to China are subject to these tariffs, which range from 5−25%. In addition to tariff lines that specifically reference valves, many other products from China that are used in making valves also are subject to Section 301 tariffs.

The future of these tariffs is far from certain. On Dec. 1, President Trump met with Chinese President Xi Jinping during the G20 Leaders’ Summit in Argentina and agreed to a temporary “cease fire,” which delayed any escalation of the existing tariffs for another three months, but didn’t do away with the tariffs that are already in place. Whether 90 days is enough time for China to commit to the trade and economic reforms sought by the U.S. government as a condition for removing existing Section 301 tariffs remains to be seen, as does how long it may be before changes would be implemented. A variety of potential outcomes is possible; potential paths include long-term continuation of the tariffs on Chinese and U.S. products, an agreement to phase out tariffs over time as Chinese intellectual property practices change, de-escalation in specific industry sectors and more.

HOW WE GOT HERE

On Aug. 14, 2017, President Trump issued a presidential memorandum to U.S. Trade Representative (USTR) Robert Lighthizer directing him to determine “whether to investigate any of China’s laws, policies, practices or actions that may be unreasonable or discriminatory and that may be harming American intellectual property rights, innovation, or technology development.”1

The initiative was a major component of the President’s ongoing efforts to address the nation’s trade imbalances, promote reciprocal treatment of American exports and strengthen the domestic manufacturing base. President Trump specifically cited in his memorandum the role of China’s practices in inhibiting and undermining American manufacturing, services and innovation.2

On Aug. 18, 2017, the USTR office initiated a formal investigation under the Trade Act of 1974 to determine whether China’s acts, policies and practices “related to technology transfer, intellectual property and innovation are unreasonable or discriminatory, and burden or restrict U.S. commerce.” USTR conducted a seven-month investigation, including consultations with advisory committees as well as a public hearing and comment period. The office issued findings in March 2018, concluding that China:

Uses foreign ownership restrictions to force technology transfer from U.S. companies;
Forces U.S. companies to enter into unfavorable licensing agreements;
Facilitates investment in U.S. companies to acquire cutting edge technologies; and
Supports unauthorized intrusions into and thefts from U.S. networks.

Specifically, USTR determined that China’s actions, policies and practices were actionable under Section 301 of the Trade Act of 1974. Subsequently, on March 22, 2018, President Trump directed a three-pronged response: (1) tariffs on Chinese exports to the United States; (2) the pursuit of dispute settlement proceedings in the World Trade Organization; and (3) restrictions on Chinese investment in the United States.

On April 3, USTR announced $50 billion in proposed tariffs under Section 301. Within 24 hours, the government of China announced $50 billion in proposed retaliatory tariffs, thus beginning a months-long “tit for tat” escalation of both duties and rhetoric.

THE TARIFFS

Since July, the United States has proposed and imposed three separate tranches of Section 301 tariffs (via three lists of products) on a wide range of products imported from China. The tariff proposals have attracted thousands of written comments and about 600 witnesses at public hearings, with both supporters and detractors. The tariffs now cover about $250 billion worth of Chinese imports including:

A 25% tariff on $34 billion worth of Chinese imports, covering 818 Harmonized Tariff Schedule (HTS, also known as the customs category) subheadings, took effect July 6, 2018;
A 25% tariff on $16 billion worth of Chinese imports, covering 279 HTS subheadings, took effect Aug. 23, 2018; and
A 10% tariff on $200 billion worth of Chinese imports, covering 5,745 HTS subheadings, took effect Sept. 24, 2018. [This is the tariff rate that would have increased to 25% on Jan. 1, 2019, a move now on pause for three months while the two governments work toward a comprehensive solution.]

President Trump’s threats to impose an additional round of tariffs on about $267 billion worth of Chinese imports, which would result in tariffs on effectively all Chinese imports, is also on pause, but could be put in place if the U.S. does not reach an agreement with China on a path forward.

The Administration’s first $50 billion in tariffs targeted what USTR deemed “industrial significant technologies,” particularly those that benefit from China’s “Made in China 2025” plan and other similar industrial policies. The made in China program is Beijing’s 10-year state plan to rapidly develop the country’s advanced manufacturing prowess in 10, high-tech industries such as robotics and aerospace. The $200 billion tranche, however—implemented in response to China’s retaliatory action—was much broader, targeting a wide-range of industrial products and consumer goods from seafood and steel to baseball mitts and handbags.

With each round of tariffs imposed by the U.S., China has immediately imposed a subsequent round of retaliatory tariffs. To date, China has imposed tariffs on $110 billion worth of U.S. exports to China. Like the U.S. tariffs, the first two rounds of Chinese retaliatory tariffs are at a rate of 25%. For the most-recent round, the tariff rate ranges from 5-10% with a pledge to increase rates when and if the U.S. raises the tariff rate on its most recent tranche. This type of “you punch me, I punch you” behavior is standard trade war practice.

EXCLUSION PROCESS

Shortly after USTR imposed its first tranche of tariffs, the office developed a process to consider excluding particular products within an HTS subheading from the tariffs. It did so in response to concerns raised by domestic industries. USTR said it may consider factors such as whether a product is available from a source outside of China, whether additional duties would cause severe economic harm to U.S. interests and whether a product is strategically important or related to Chinese industrial programs, including “Made in China 2025,” among other factors. USTR also provided a process for domestic interests to object to exclusion requests and for requestors to respond to those objections.

The application period for exclusion requests for the first tranche of tariffs ended Oct. 9, 2018, and USTR continues to process requests. As of Nov. 20, 2018, the office had denied about 1,080 and approved none of the 10,650 exclusion requests from that first tranche. At press time (December 2018), USTR had reviewed and posted about 600 requests from the second tranche.

For the third tranche of tariffs, which took effect Sept. 24 and covers 5,745 HTS numbers, an exclusion process is not currently planned. In forestalling an exclusion process, the Trump Administration stressed the need for companies to shift production and supply chains away from China. Not making an exclusion process available has drawn criticism from domestic business interests and some members of Congress. Pressure on the Administration to consider exclusion will likely intensify if the current trade cease fire ends without resolution and tariff rates are set to increase next year.

OPTIONS FOR MANUFACTURERS

USTR’s product exclusion request process is one option for domestic interests for whom the additional tariffs would cause economic harm or who may be unable to find alternative sources. However, it is uncertain how liberal USTR will be in granting exclusions. If domestic production of the covered items exists and the domestic manufacturer comments in opposition to the exclusion request, chances are not good that an exclusion would be approved. Those companies that manufacture a product in the U.S. on a U.S. list that would like to see that product remain there could consider monitoring the exclusion request lists and objecting to exclusion requests. Note that, as mentioned above, this is not available at press time for products on list 3.

Another approach is to take steps to diversify the company’s supply chain by finding component sources outside of China. This is often easier said than done because some companies have put in untold hours locating, qualifying and working with Chinese suppliers to get a reliable supply of good products. Other companies have made or established manufacturing facilities of their own in China with significant investments. Beyond major supply chain modifications, other options are available to ameliorate tariff impacts for U.S. manufacturers, including:

Country of Origin. The Section 301 duties are based on country of origin, not country of export. U.S. importers considering further processing of Chinese products in other countries (e.g., moving Chinese-origin products to Canada, Mexico or another destination for further processing before importing into the U.S.) must be careful to comply with U.S. customs laws and avoid accusations of Section 301 evasion. Currently, a dispute has arisen about whether qualification for the North American Free Trade Agreement origin is sufficient to avoid designation as a Chinese-origin item under Section 301. In short, it would be wise not to make assumptions about origin determinations, and qualified trade counsel should be consulted on this issue.
Drawback. The Section 301 duties are eligible for duty drawback, meaning tariffs on imported goods may be refunded if imported products are subsequently exported out of the U.S. Companies that do enough exporting could consider setting up a drawback program. Again, this involves some complex customs so getting assistance is wise.
First Sale. While first sale valuation does not eliminate the additional 301 duties, it can provide duty savings by reducing the value of the product on which the duty is applied. It is important to set up a first sale system the right way.
De Minimis. Finally, small quantities of covered products entered under the Section 321 de minimis exception are not subject to Section 301 duties.
Foreign Trade Zones (FTZ). For goods entered after the effective date, FTZs cannot be used to avoid Section 301 duties.

WHERE TO FROM HERE?

The Trump Administration has repeatedly stated it needs to see major concessions and commitments from the Chinese before it will consider removing the 301 tariffs. Specifically, the United States has purportedly prepared a list of nearly 150 items it wants the Chinese government to address. In addition to pressuring China to stop noneconomic transfers of industrially significant technology and intellectual property to China, the United States wants to see China remove a variety of tariff- and non-tariff barriers that make it difficult for U.S. businesses to operate in China. President Trump also has repeatedly stressed his desire to ensure that tariffs between the two countries are reciprocal in value.

The Dec. 1, 2018 announcement by Presidents Trump and Xi kicked off a 90-day period of trade negotiations that could lead to a more comprehensive deal. In addition to the freeze on existing tariffs and rates, China agreed to purchase what the White House has described as “very substantial” amounts of agricultural, energy, industrial and other products from the United States to reduce its existing trade surplus. The leaders also agreed to begin negotiations at the highest levels of their governments to try to resolve the current trade conflict. Therefore, it appears there is some hope on the horizon. However, numerous unsuccessful efforts to negotiate on these issues in 2018 and so far in 2019 have occurred.

For now, tariffs remain on $250 billion worth of Chinese imports: a 25% tariff on an initial $50 billion in Chinese goods and a 10% tariff on the remaining $200 billion. Chinese retaliatory tariffs also remain in place. The Trump Administration has indicated all tariffs could be phased out if China delivers on significant structural reforms. The details of those reforms and how much substantive change the U.S. will need to see before eliminating any tariffs remains to be seen. If an agreement is not reached by March 1, 2019, President Trump has indicated he is prepared to increase 10% tariff rates on that $200 billion worth of goods to 25%—and could impose additional tariffs on remaining Chinese imports. Given the high degree of uncertainty, companies would be wise to continue preparing for a protracted period of tariffs.

ERIC MCCLAFFERTY is a partner in Kelley Drye’s International Trade Law practice. He advises a wide variety of companies in the fluid handling industry on import, export and trade policy/regulatory issues.

MAGGIE CROSSWY is an advisor in the firm’s Government Relations and Public Policy practice. She focuses on lobbying and monitoring legislative and regulatory issues, primarily in the areas of manufacturing and international trade.

Reach them at (202) 342-8841 or emcclafferty@kelleydrye.com.