The Generalized System of Preferences (hereinafter referred to as the “GSP”) is a generalized, non-discriminatory and non-reciprocal system of tariff preferences granted by developed countries to developing countries for the export of finished and semi-finished goods. Since there is no unified concept for developing countries, the “beneficiary developing countries” (BDCs) identified by preference-giving countries vary. However, with the accelerated pace of "going out" of Chinese enterprises, especially the investment in the Belt and Road countries, the products produced by the overseas affiliates of Chinese enterprises may be exported to the United States and enjoy duty-free treatment because of its origin. Therefore, products imported from those countries may be subject to investigation by the Department of Homeland Security, U.S. Customs and Border Protection (hereinafter referred to as the "CBP").

The purpose of GSP is to eliminate substantive inequalities with formal inequalities. It is set up to promote the economic development of developing countries as well as the development of the international community as a whole, with an overtone of helping the poor and the needy. As the GSP is a non-contractual international multilateral agreement, developed countries are usually free to establish GSP schemes following their legislative procedures, hence the BDCs, eligible products and criteria of different preference-giving countries vary. For instance, the United States outperforms Canada in terms of the percentage of local content in the country of origin alone.[1]However, the U.S. conditions the comparison with the local content of materials in the country of origin on the appraised value of the product rather than the cost. It means that in the case of more profitable export sales, it will be difficult to meet the essential criteria and should not enjoy the preferential treatment which should have been applied to less competitive products.

The GSP is the oldest trade preference scheme in the United States, designed to provide duty-free treatment for more than 5,000 products from approximately 120 BDCs. Under this scheme, US$21 billion worth of products were imported duty-free into the United States in 2019.[2]Authorized by the Trade Act of 1974, the U.S. GSP was formally implemented on 1 January 1976 and has been extended 14 times, most recently on 23 March 2018, until 31 December 2020.

Although it has expired, this is not the first time that the U.S. GSP has expired. According to precedent, of the last 14 expirations, all but four were extended prior to expiry and the remaining 10 were extended retroactively after expiry, and all products imported during the expiry period will receive a duty refund.[3]It is therefore understandable why CBP issued a notice on 21 December 2020 encouraging importers to continue to mark their products as GSP-eligible on customs declarations starting from January 1, 2021.[4]

1.  BDCs and eligible goods

Under the Trade Act of 1974, the President of the United States is required to consider a country's level of economic development, degree of free trade, market access, and level of protection of internationally recognized workers' rights and intellectual property rights when identifying BDCs. In addition, a country will be excluded when the President determines that it has expropriated or seized ownership or control of property of a U.S. person, has failed to recognize or enforce in good faith arbitral awards in favor of U.S. citizens or has supported terrorist activities.[5] It can be seen that the U.S. GSP is not simply an aid to developing countries, with inappropriate political or other conditions being attached. China has been excluded from the list of BDCs identified by the U.S. A detailed list can be found on the CBP website.[6]

Under U.S. Customs laws, not all products originating in the BDCs are eligible for duty-free treatment and the authority usually identifies eligible products according to the needs of its trade and economic policy and adjusts the list from time to time. Eligible items are identified by the symbols “A”, “A*” or “A+” in the “Special” sub-column of the Harmonised Tariff Schedule of the United States (HTSUS). Entries claiming GSP benefits must add SPI “A” as a prefix to the tariff number. As shown in the chart below, “A” indicates that all BDCs are eligible, “A+” indicates GSP treatment applies when the product is imported from a least developed beneficiary country, and “A*” indicates that certain GSP countries are ineligible.

It should be noted that certain sensitive products such as textiles, apparel, watches, electronic articles, steel and glass products, and certain agricultural products are ineligible.[7]

The GSP Subcommittee of the Trade Policy Staff Committee (TPSC) is responsible for the annual review of the list of BDCs and products eligible for GSP benefits, with the President making the final decision. For example, in May 2019, U.S. President Donald Trump terminated Turkey's GSP treatment in view of its level of economic development.

2.GSP eligibility

In order for an eligible article manufactured in a BDC to qualify for duty-free entry into the U.S. under the GSP, the following conditions must be satisfied:

(i) The article must be a “product” of the BDC, which means that the product either is wholly the growth, product or manufacture of the BDC or if any of the non-originating materials undergo a double substantial transformation within the BDC；

(ii) The product must be directly imported from the BDC；

(iii) The cost of value of materials produced in the BDC plus the direct cost of processing must be not less than 35% of the appraised value of the imported merchandise；

(iv)Importers must apply for GSP treatment by marking the appropriate SPI (A, A+, or A*) code as a prefix before the HTSUS code for the imported product on Customs Form CF7501 (Import Declaration).

Of these, criteria 1, 2 and 4 are easier to understand. These are basic GSP requirements relating to the origin, direct shipment and filing, and many countries have similar rules, which will not be explained in detail here. With regard to criterion 3, the value-added percentage, the U.S. Customs formula is as follows:

The result of the above calculation must be at least 35% to qualify for GSP. We discuss each of these elements below.

（1）Cost of Value of Materials Produced in Beneficiary Developing Country or Materials Undergo that Double Substantial Transformation

Unlike the criterion for determining country of origin, i.e., substantial transformation, a more stringent criterion of double substantial transformation is adopted in the GSP value-added calculation. Double substantial transformation means that the imported material must first be substantially transformed in the BDC into a new and different intermediate article of commerce, i.e. with a new name, characteristics and use, and then the intermediate article of commerce must be substantially transformed again in the BDC into the final imported article.

The purpose of the double substantial transformation rule is to ensure that a significant portion of the value of the good results from processing performed in the BDC and/or materials that originate in the BDC. Thus, materials from a third country can be counted as local content for purposes of the numerator of the GSP calculation only if they undergo two separate levels of substantial transformation in the BDCs. That is, the third-country components must first be substantially transformed in BDCs into a new and different intermediate article of commerce, which is then used in BDCs in the production of the final imported article.

For instance, if company A wants to include the cost of raw materials not originating in the BDC (e.g. scrap steel) in the numerator of the value-added calculation, it would need to demonstrate that the imported scrap steel first undergoes a substantial transformation in the BDC into a distinct intermediate product (e.g. steel bars), which needs to be a commodity (preferably one sold on the commercial market), and then demonstrate that the intermediate product undergoes a further substantial transformation into the imported product(e.g. fasteners) to the U.S. If a non-originating material does not undergo a double substantial transformation in the BDCs, it cannot be counted towards the 35% calculation. CBP can require documentation to substantiate any of the costs included in the cost of materials calculation.

In addition to the aforementioned key criteria of product name, characteristics and use, CBP will usually consider a number of other factors such as the manufacturing process, the production process and the cost of production of the products. In order to obtain certainty, interested parties can refer to the past Customs rulings. A summary of some classical rulings relating to double substantive transformation is set out below.

（2）Direct costs of processing

The GSP calculation also includes the following direct costs of processing in the 35% threshold:

(i) All actual labor costs involved in the growth, production, manufacture, or assembly of the specific merchandise, including fringe benefits, on-the-job training, and the cost of engineering, supervisory, quality control, and similar personnel;

(ii) Dies, molds, tooling, and depreciation on machinery and equipment which are allocable to the specific merchandise;

(iii) Research, development, design, engineering, and blueprint costs insofar as they are allocable to the specific merchandise; and

(iv) Costs of inspecting and testing the specific merchandise. [8]

Profit and general expenses of business not allocable to the imported merchandise may not be included as direct costs of processing.[2] In practice, CBP does not usually accept the inclusion of profit in the direct processing costs.

（3）Appraised value

The denominator of the GSP calculation is the “appraised value,” which means the entered value declared on the CF7501. There are several methods used to declare entered value to CBP. We provide a general overview of these methods below. 

A.  Transaction Value

Under U.S. Customs law, the default value to be reported to CBP at the time of entry is generally the “transaction value.” The transaction value is defined as the price paid or payable by the buyer to the seller for the imported merchandise, including any indirect payments, when sold for exportation to the United States.[10]

In order for the transaction value method to be used, there must actually be a payment by the buyer to the seller, meaning a bona fide sale. If there is no bona fide sale, a different basis of appraisal must be used, though the payment by the buyer to the seller can be made after the time of importation.  A mere bookkeeping credit between the parties is not sufficient to show a bona fide sale. There must be a transfer of title for consideration.[11]

Where the conditions for a bona fide sale are met, the parties still need to demonstrate whether the price of the transaction is fair market value. For example, whether there is a relationship between the buyer and seller and whether such relationship affects the price actually paid or payable. In the case of related parties, CBP determines whether the relationship influenced the price by looking at either of two tests: 1) circumstances of sale or 2) test values.[12] In other words, CBP wants to be sure that the price is not kept artificially low between a related buyer and seller in a way that understates the dutiable value (and lowers duties owed to CBP) and any applicable taxes. This is similar to the regular Customs investigation of the valuation of imported products.

Under the “circumstances of sale” test, the transaction value is acceptable if an examination of the circumstances of the sale indicates that the relationship between the buyer and the seller did not influence the price by examining whether:

- The price was settled in a manner consistent with the normal pricing practices of the industry in question;

- The price was settled in a manner consistent with the way the seller settles prices for sales to buyers who are not related to it; or

- The price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm’s overall profit (generally, the ultimate parent company’s profit is used for this purpose). [13]

Normally, the best way to prove the above is through third-party, audited pricing studies and/or audited financial information.

Under the “test value” method (which is rarely used) the transaction value between a related buyer and seller is acceptable if it closely approximates: (i) the transaction value of identical merchandise, or of similar merchandise, in sales to unrelated buyers in the United States; (ii) the deductive value or computed value for identical merchandise of similar merchandise.[14]

In addition, based on the correct valuation of the transaction price, interested parties may apply for adjustments to expenses associated with the transaction price, such as packaging fees, commissions, royalties or license fees, shipping and insurance fees, etc.

B.Transaction value of identical/similar merchandise

Where the transaction value is not a permissible methodology, the next available method of valuation is to report the transaction value of identical or similar merchandise exported to the United States at or about the same time as the merchandise being imported. [8]The value of the identical or similar merchandise must actually have been accepted on past transactions and cannot be hypothetical.

C.  Deductive value

Where the above methods cannot be used, CBP next looks to deductive value. Deductive value is essentially the resale price in the United States after importation of the goods, with deductions for certain items. The basis of deductive value is generally the “unit price” at which merchandise is sold in the United States in the greatest aggregate quantity “at or about the date of importation.”[16]

The following deductions are allowed from deductive value: (i) commissions paid or profit and general expenses, (ii) transportation and insurance costs, (iii) customs duties and taxes, (iv) the value of further processing if merchandise is not sold in the condition as imported.[17]

D.  Computed value

Where the above methods cannot be used, CBP next looks to computed value, i.e., the sum of (i) the cost or value of the materials, fabrication and other processing; (ii) an amount for profit and general expenses; (iii) any assist and (iv) the packing costs. The importer can also ask to use computed value over deductive value by requesting CBP at the time of entry.[11]

E. Fallback method

Where the value of imported merchandise cannot be determined or otherwise used, the imported merchandise is appraised on the basis of one of the above valuation methods “reasonably adjusted to the extent necessary to arrive at a value.”[18] This method typically requires CBP approval but is generally one of the above methods modified in a way that accounts for extraordinary circumstances in an import transaction.

It is the importer’s responsibility to properly declare a proper entered value to CBP. Even if CBP has not objected to the valuation on past entries, that does not mean that it has accepted an importer’s valuation method.

U.S. Customs investigations are different from general administrative investigations, and it has a quasi-judicial nature. Under the U.S. Customs law, importers are responsible to declare authentic and accurate information on Customs documents regarding the classification of the product, the appraised value, the country of origin as well as the anti-dumping/countervailing duties at the time of entry. By review the documents, CBP ensures the declarations and import procedures comply with the applicable rules and regulations. Moreover, it also has the right to trace imported products after the completion of the liquidation process. Any misdeclarations, irregular activities or false information may result in additional duty or penalty assessment and, in serious cases, criminal sanctions.

1.Investigation procedures

If after the entry has been made, the CBP has questions about information related to the imported product, it may issue a Form 28 questionnaire (Request for Information) to the importer requesting additional information. This information usually includes various documents such as sales literature, production flow charts, costing sheets and certificates of origin of raw materials. These documents are used by the CBP to verify the accuracy of the information declared.

When receiving the Form 28 questionnaire, the importer usually has 30 days to file a response, in most cases an extension can be granted upon request. If the importer does not submit a response within the required time frame or if the response is deemed incomplete, CBP will send a Form 29 questionnaire (Notice of Action) to make a final decision on the matter subject to review. Once CBP has received a response, there is no legal deadline within which it should provide feedback (some importers receive a response within weeks, some not for months) and if there are questions about the documents submitted, the officer will contact the attorney or importer. However, for the importer, no feedback may be the best feedback.

In the case of the GSP investigation, for instance, after receiving the importer's Customs declaration documents and GSP application, the CBP may also issue Form 28 to request additional information such as detailed production and sales data. The submission of the requested data within the required 30 days can be costly in terms of manpower, material and financial resources. For an entry subject to investigation, the importer can generally provide sales documents such as invoices, contracts and payment vouchers which can only be used to prove the country of export, the imported product, the manufacturer of the product and the price of the transaction, which is, however, far from the requirement. In this context, this not only requires the importer to maintain close contact with the exporters and be able to convince them to cooperate, but also challenges the internal control compliance systems of the exporters and their upstream raw material suppliers. However, since the burden is on the importer rather than the exporter to demonstrate that entered value is properly declared and it is also often the case that the exporter's financial and supply chain systems do not include the function of proving the origin of the product, making it difficult to understand the investigation requirements and provide sufficient evidence to prove the origin of raw materials and information on the unit consumption of a particular product in a short period of time. Therefore, the correct approach is for the importer to have a thorough understanding of the exporter and its products at the time of importation, and to make a GSP declaration only when it is certain that the product to be imported meets the GSP requirements.

If an interested party disagrees with the results of the investigation, the importer, broker or attorney may file a Protest with CBP within 180 days of the liquidation of the entry. There is no set form for filing a protest, as long as it is clearly stated and signed by the applicant. However, CBP recommends that this be done by completing a Form 19 questionnaire. The questionnaire includes information about the applicant, the reason for submitting the objection, information about the imported product and whether an expedited process is required.

2. Lost duties and penalties

CBP has the authority to collect lost duties for entries within the last five years. That means that even if an entry is liquidated, CBP can make a demand for any duties it believes were not properly paid up the five years from the date of entry of imported merchandise (in cases of fraud, this period is five years from the date of discovery of the fraud).

On top of demanding lost duties, even if there is no revenue loss to the U.S. government, CBP can assess additional penalties. Under U.S. law, “no person, by fraud, gross negligence, or negligence - (A) may enter, introduce, or attempt to enter or introduce any merchandise into the commerce of the United States by means of (i) any document or electronically transmitted data or information, written or oral statement, or act which is material and false, or (ii) any omission which is material, or (B) may aid or abet any other person” in such action.

In general, penalties for a Customs law violation are as follows:

Note that liability for customs violations is not limited to the importer of record and we have seen an expansion in recent years of CBP seeking duties against other individuals/companies if they are directly involved in making false statements or omissions to CBP in entering merchandise. For instance, in United States v. Trek Leather, the court held that the owner and shareholder of the importer shall be liable for Customs duties and penalties.[22] In United States v. Deladiep, the court found that the owner of the company who made false statements to CBP in entering merchandise into the United States was liable for penalties where they knew that the imported merchandise was subject to AD/CVD.[23] In addition, CBP has also sought lost duties/penalties from foreign suppliers. In United States v. Fenderson, the proceeding under 1592 was against a Canadian exporter, as well as the U.S. importer and customs broker, based on the foreign exporter’s misrepresentation of the value on the pro forma invoice that the importer/broker used to make entry into the United States.[24]

3. Remedies

There is no automatic liability, however, CBP must follow a specific regulatory process before imposing lost duties and penalties under section 1592, giving the importer an opportunity to object to the duty demand and/or penalties and show why its valuation or failure to pay duties (or other issues) was reasonable and why any penalty should be mitigated to a lower amount. The reasons for applying for mitigation include the degree of cooperation with the customs, whether remedial measures are taken in time, good historical records and so on. Importers can also appeal penalties or defend against the application of duties at the Court of International Trade.

A person seeking to eliminate or reduce potential penalties (but not unpaid duties) under Section 1592 can do so by filing a prior disclosure with CBP. Filing a prior disclosure can have significant benefits by reducing any penalties to only the interest on lost duties in the case of negligence or gross negligence as shown in the chart set forth above. To take advantage of the lower penalties available for filing a prior disclosure, the party must have no knowledge of the commencement of a formal investigation of the issue by CBP. Usually, when the importer receives the Form 29 questionnaire, the investigation officially initiates.[25]

In recent years, due to frequent targeting by U.S. trade remedies investigations and the impact of China's Belt and Road initiative, many Chinese companies have chosen to locate their factories in regions such as Africa and Southeast Asia, not least out of a desire to take advantage of the U.S. GSP. However, the strategic blueprint of multinational companies has also come to the attention of U.S. authorities, which have even directly stationed officers at some U.S. embassies in Southeast Asian countries to extend CBP inspections to overseas production bases.

Having understood and grasped the foregoing explanation, enterprises should also note that the GSP is a form of differential treatment granted to the less developed party. Even if the imported product is eligible for GSP, it may not be possible to meet the 35% requirement if the export price is high at a certain stage or if there is a comparative advantage. In this case, there is no need for the enterprises to stick to the advantage of preferential duty. The improvement of the market value of the product itself shall be the priority. Furthermore, the GSP is applied on a country and product basis and a transaction that fails to meet the requirements does not mean that the product is not of that country's origin, nor does it mean that other transactions may not be eligible for the preferential treatment. In the event of a change in the market and a fall in prices, imports may continue to benefit from the GSP if the conditions are met.

In addition, companies need to be aware of the non-reciprocal, temporal effectiveness and supportive nature of the U.S. GSP. Only in this way can they be fully prepared to establish a global strategic layout and diverse the sales option to maximize the benefits.

First of all, non-reciprocity is the most important characteristic of the GSP. It is a unilateral commitment of developed countries and a special provision made to spur the economic development of developing countries. It has become a very significant feature of today's economic and trade relations between developed and developing countries. In the list of most preference giving countries, members of G77 are generally granted GSP treatment, and Mongolia, Israel, China and other countries that do not belong to the group are also included. However, there are still a few countries that should be developing countries according to their level of economic development, but they have not been granted GSP treatment.

Secondly, the conditions for granting GSP are set by the developed countries themselves. Whether it is the duration, product, country or specific conditions, the major developed countries such as the European Union, Canada, Japan, Australia and the U.S. vary, and enterprises must comply with the requirements of each country when applying GSP. According to a report published by UNCTAD, countries such as Australia, Russia, New Zealand and Switzerland currently grant GSP to products originating in China.[26]

Thirdly, in complying with the UNCTAD initiative, countries agreed that "the objectives of the GSP should be to increasing the export earnings of developing countries, to promote their industrialization and to accelerate their economic growth rates."[27]However, they all limit, to varying degrees, the extent to which they can grant benefits to agricultural products from developing countries, so that developed countries do not ignore their fundamental economic interests while helping developing countries.

Fourthly, the U.S. Customs GSP investigations are generally directed at the individual transaction, and the fact that this transaction fails to meet the 35% condition does not mean that other transactions from the same country, the same product or even the same exporter do not also meet the condition. Whether it is a change in the source of the materials, an increase in the percentage of local manufacturing costs, or the transaction price, may present a completely different picture in each transaction. However, the investigation of a transaction will reflect the general situation of the importer's declaration of GSP, on the basis of which U.S. Customs will determine whether additional transactions are needed for further investigation.

In addition, the following mechanisms of GSP also show its characteristics of supportive and temporal effectiveness:

(i) Escape clause, whereby the preference-giving country reserves the right to withdraw GSP treatment in whole or in part for a product when the quantity of that product imported by the preference-giving country from the BDC increases to such an extent as to cause or be likely to cause serious injury to manufacturers of the same or like products or of products in direct competition in that preference-giving country.

(ii) Prior limitation, which specifies the amount or quantity of preferential exports of a particular type of product for a certain period of time (usually one year), and if the BDC's exports to the preference-giving country exceed this limit, the GSP ceases and normal duty, i.e., the MFN rate, shall apply. For example, the U.S. GSP provides that if in any one year U.S. imports of a product from a BDC account for 50% or more of total U.S. imports of that product, or if imports of that product exceed a certain limit (US$195 million in 2020, with this limit increasing by US$5 million each year), the product will be considered competitive and its GSP treatment will cease on 1 November of the following year.[28]

(iii)   Graduation clause, i.e., when a product or the economy of certain BDCs has reached a relatively high level of development and has demonstrated a high level of competitiveness in the world market, the GSP treatment for that product or all products will be withdrawn.

In summary, we recommend that companies considering the GSP as a factor for overseas investment should pay close attention to the updates of the U.S. GSP, identify the BDCs, the eligible products, and compare the difference between the preferential and MFN duties. On this basis, it is recommended that companies shall balance the advantage of the GSP and the compliance costs which will provide a basis for determining the sales channel and export prices.