BlackSwan Zine

By Luciana Suran

Job losses continue and the economic recovery is only just beginning; however, one bright spot is the strong rebound in trade evident in the GDP data. Since reaching a trough in early 2009, both imports and exports have increased by more than 17%.

An aspect of U.S. trade not often discussed is Foreign Trade Zones (FTZs). FTZs are the U.S. version of free trade zones—areas in which businesses and manufacturers enjoy reduced trade tariffs and tax breaks. Many are located in developing countries like China, Brazil, and Mexico. Their American equivalents receive relatively little attention. That should soon change, however—especially among those in the industrial real estate business.

A short backgrounder on FTZs: FTZs are the U.S. form of free trade zones and are restricted-access sites in or near ports of entry that operate under public utility principles to create and maintain employment by encouraging operations in the U.S. which might otherwise have been carried on abroad. These zones in the U.S. are licensed by the Commerce Department’s Foreign-Trade Zones Board and are under the supervision of U.S. Customs and Border Protection and for the purposes of taxes and duty payments are regarded as outside the customs territory of the U.S. Foreign goods imported into FTZs, if then processed or re-manufactured and sent to a foreign country, are exempt from state and local ad valorem tax. are not taxed. If they do enter the U.S. market, they are taxed only when they are taken out of the FTZ. The latest available information indicates that there are 164 active FTZ projects, representing about 2,500 firms with 330,000 employees. The combined value of shipments into FTZs totaled $692.6 billion in 2008—a whopping 127% increase over 2007. (Notably, the number of FTZ zones did not increase significantly during the same time period.)

Goods Received by Foreign Trade Zones Have Risen Significantly

Source: U.S. Customs and Border Protection, 70th Annual Report of the FTZ Board to Congress

Why Companies use Foreign-Trade Zones

All of the benefits the Foreign-Trade Zones program can offer manufacturers and processors located in the United States are too numerous to list here. But, there are a few main benefits that account for most of the companies that use the Zones program. Those benefits are listed below:

• Relief from inverted tariffs—in certain instances, there are tariff (import duty) relationships that actually penalize companies for making their product in the United States. This occurs when a component item or raw material carries a higher duty rate than the finished product. Hence, the importer of the finished product pays a lower duty rate than a manufacturer of the same product in the United States. This gives the importer an unfair and unintended advantage over the domestic manufacturer. The Foreign-Trade Zones program levels the playing field in these circumstances.FOR EXAMPLE: A Foreign-Trade Zone user imports a motor (which carries a 4% duty rate) and uses it in the manufacture of a vacuum cleaner (which is free of duty). When the vacuum cleaner leaves the FTZ and enters the commerce of the U.S., the duty rate on the motor drops from the 4% motor rate to the free vacuum cleaner rate. By participating in the Zones program, the vacuum cleaner manufacturer has virtually eliminated duty on this component, and therefore reduced the component cost by 4%.

• Duty exemption on re-exports—without a zone, if a manufacturer or processor imports a component or raw material into the United States, it is required to pay the import tax (duty) at the time the component or raw material enters the country. However, a Foreign-Trade Zone is considered to be outside the commerce of the United States and the U.S. Customs territory. So, when foreign merchandise is brought into a Foreign-Trade Zone, no Customs duty is owed until the merchandise leaves the zone and enters the commerce of the United States. Only then is the merchandise considered imported and the duty paid. If the imported merchandise is exported back out of the country, no Customs duty is ever due.
• Duty elimination on waste, scrap, and yield loss—again, without a zone, an importer pays the Customs duty owed as material is brought into the United States. This is because the material is considered imported at this point. If the processor or manufacturer is conducting its operations within a zone environment, the merchandise is not considered imported, and therefore no duty is owed until it leaves the zone for shipment into the United States. To demonstrate how this would benefit a company that has scrap, waste, or yield loss from an imported component, let’s look at a chemical processing plant.FOR EXAMPLE: A chemical plant manufacturing hydroxywidgitpropolyne, which carries a 15% duty rate, uses the raw material oxyovertaxophene, which also carries a 15% duty rate, for one of its raw materials. Part of the production process consists of bringing the imported oxyovertaxophene to extreme temperatures. During this process 30% of the oxyovertaxophene is lost as heat. If a processing company not in the Zones program imports $10,000,000 per year of oxyovertaxophene, it will pay $1,500,000 in duty as the raw material enters the United States.If the same company utilizes the zones program, it does not pay duty on the oxyovertaxophene until it leaves the zone and is imported into the United States. The zone user brings the oxyovertaxophene into the zone with no duty owed. It then processes the oxyovertaxophene into hydroxywidgitpropolyne. Remember, during this process 30% of the raw material is lost due to waste factors, so the $10,000,000 in oxyovertaxophene is now worth only $7,000,000. Assuming all of the end product is sold into the United States, the 15% Customs duty totals only $1,050,000. This represents a savings of $450,000.While at first glance it might look like the Zones program is simply benefiting an importer, it is important to remember that its competitors making the same product overseas already have the benefit of not having to pay on the yield loss in the production of their whatever.

• Duty Deferral—Again, since Foreign-Trade Zones are outside the Customs territory of the United States, goods are not imported until they leave the zone. Therefore, Customs duty is deferred until merchandise is imported from a Foreign-Trade Zone into the United States. So, instead of companies having substantial monies tied up in Customs duties on their inventory, they have use of that money for other purposes.

Recently, there has been a flurry of activity around U.S. FTZs. Companies are looking to cut costs wherever and however they can, and locating a business in an FTZ is one way of doing so. It’s not too surprising then, that a number of new and expanded FTZs are in the works. Officials in Riverside County—a key distribution market and one of the largest industrial markets—are trying to expand their FTZ, as are others in Kansas City, Atlanta, and Madison County, Ill., among many others. A new FTZ was approved in Kern County, Calif. earlier this month; it includes sites at Bakersfield’s Meadows Field Airport and at the Tejon Industrial Complex in Lebec.

New, streamlined procedures issued by the U.S. Department of Commerce that make it easier for businesses to receive foreign trade zone designation are another factor likely to lead to an increase in leasing activity in FTZs. Previously, the expensive process took more than a year to complete but now will be shortened to less than 45 days, with lower costs incurred. The Dallas-Fort Worth FTZ, located in and around the Dallas-Fort Worth International Airport, will be the first to take advantage of the new regulations and will expand coverage to surrounding counties, which will likely lead to new leasing activity in the area. The area surrounding the airport is already in high demand-industrial facilities located in the DFW Airport submarket of Dallas (the submarket in which the FTZ is located) have experienced only one quarter of negative net absorption since the recession began near the end of 2007. Our data on the Dallas market as a whole, on the other hand, show negative net absorption for the previous seven quarters.

Those who are like me and approach April 15th with  trepidation can take heart in the fact that at least some things in this country aren’t taxed!