Managing Customs in a Small or Medium Size Organization

Most small and medium sized organizations do not import often enough to hire a full-time customs manager. The job tends to be a part-time responsibility of someone in accounting or logistics or, in many owner-managed businesses, the President. The biggest challenge for this part-timer is having sufficient knowledge of trade and customs matters to provide the customs broker with complete and accurate information.

This article describes the basic knowledge that a customs manager needs to make the best use the more extensive knowledge possessed by their customs broker. It also provides links to articles that provide more in-depth information and links to outside sources of knowledge.

Importers tend to assume that brokers have all the knowledge required to prepare the customs entry documents. Brokers do know a lot about customs and trade. However, their knowledge of a particular import shipment is generally limited to the information on the customs invoice and other transaction-related documents provided to them. They do not review underlying legal documentation, such as purchase and sale contracts, and they don’t have much time to ask probing questions.

For example, if a customs invoice states that the price includes installation of a machine on site in Canada, the broker will ask for the information necessary to deduct the installation costs in determining the value. However, if the invoice simply describes the machine, the broker will assume the price includes delivery only. It is up to the importer to be aware of both the terms of the purchase contract and that the installation portion of the price may be deducted. If he is not, and the goods are dutiable, the importer will overpay.

Customs and trade knowledge falls into three broad categories: valuation, origin and tariff classification.

Valuation

Where transaction value forms the basis of valuation, as it does for 90% of imports, there are a number of statutory additions and deductions from the invoice price. Both are often missed because the customs manager lacks knowledge of the underlying contracts and/or the adjustment requirement. The most common deductions are:

  • Transportation charges and insurance from the place within the country of export from which the goods are shipped directly to Canada, and
  • Costs for construction, erection and assembly after importation.

The most common additions are:

  • Selling commissions and brokerage;
  • Certain royalties and license fees payable after importation;
  • Subsequent proceeds payable to the purchaser; and
  • Assists (goods and services provided free to the exporter).

All of the adjustments to the invoice price are described in the article entitled The Basics of Customs Valuation. The article also identifies the situations where transaction value may not be used.

Origin

The person managing customs at an importer should know the basic principles of origin. Every good that crosses a border anywhere on earth has an economic nationality known as its “non-preferential origin”. This is generally the country where the good was manufactured. However, a good must be “substantially transformed” by the manufacturing process for origin to be conferred. Not all forms of manufacturing meet this test.

A common misconception is that goods originate in the country from which they are shipped.  That is not true.  A pair of soccer boots manufactured in Indonesia, stored a warehouse in the United States and subsequently sold to a customer in Canada, remains of Indonesian non-preferential origin.  This may or may not be clear on the customs invoice provided by the American exporter.

The rules of origin that confer preferential tariff treatment under a free trade agreement are not based on the principle of substantial transformation.    Rather, they are product specific according to their tariff classification, and often quite detailed.  The rules for determining “preferential origin” under the USMCA are summarized in this article.  While the details of origin rules are different for other free trade agreements, the general framework is similar for all.

A common misconception among importers is that receipt of a certification of origin under a free trade agreement from the producer or exporter is a guarantee that the goods qualify for preferential (often duty free) treatment.  This is not the case.  If the producer has not done the work necessary to substantiate that the goods qualify under the rules of origin, or mistakenly concluded that they do, the importer is the person who is assessed for any duties, interest and penalties owing.  

The fundamentals of preferential and non-preferential origin are discussed in the article entitled The Basics of Origin in International Trade.

Tariff classification

Tariff classification is the area where study and legwork by the importer may pay the most dividends. Most brokers are experienced at classification. However, they cannot know your goods as well as you do. They can’t walk out to the warehouse to look at them and they don’t have access to the people that use them or to the product literature. Studies by customs authorities around the world have generally found that a quarter to a third of imported goods are misclassified. These errors, generally caused by poor communication within an organization, or between the importer and broker, often lead to costly assessments or overpayments of duties and taxes.

The basics of tariff classification, described in this article on the Harmonized System, are not difficult to learn. However, it takes time and experience to get used to the nuances of the system. Not all goods are specifically listed in the Nomenclature, which looks like the Manhattan phone book. Some goods are classified in obscure places; many may be classified in more that one place. If you are willing to put in the effort, you may generate significant savings in duty, interest and penalties. Your broker will be more than happy to review your work and conclusions.

Organization of the customs management function

The person managing customs at a small or medium sized organization should be the primary, and preferably only, contact with the customs broker.  That manager would co-ordinate input from others in the organization to ensure that the broker has the information to properly carry out his or her primary tasks; i.e., preparing complete and accurate customs entry documents and having the goods promptly released at the border.  The customs manager should report to a senior executive, likely the Vice-President Finance or Controller, who takes an interest in ensuring that customs and trade issues are properly addressed in the organization.

GST Recovery for Non-Resident Importers

Most commercial goods that enter Canada are subject to the federal goods and services tax (GST), the Canadian VAT. The current rate is 5% of the duty paid value. The major exceptions are for certain basic groceries, prescription drugs and biologicals, medical and assistive devices and products of agriculture and fishing. The full list of exceptions may be found in Schedule VI and Schedule VII to the Excise Tax Act.

For most business inputs such as raw materials, capital equipment and goods acquired for resale, this GST is recoverable as an input tax credit. The credit is claimed by a registrant on its regular periodic return, as a deduction against tax collected on sales made in Canada. However, importers involved in certain businesses (for example: financial services, rental of residential real estate, health care and education) may not be able to recover the tax, or may be able to recover only part of it.

Where a non-resident of Canada acts as importer of record, claiming an input tax credit often requires some thought and extra work.

GST Registration for Non-Residents

A non-resident is required to register for GST purposes if it is carrying on business in Canada or making sales from a permanent establishment in Canada. Most non-resident importers do not reach these thresholds.

A non-resident who regularly solicits orders for the supply of goods for export to, or delivery in, Canada may register voluntarily for GST purposes. That is the easiest and most direct means of claiming input tax credits. However, non-residents are often reluctant to register. They do not want to deal with the administration of collecting tax on sales made in Canada and filing returns in a foreign jurisdiction. They also wish to stay off the radar of the Canada Revenue Agency, which also administers income taxes.

Credit claimed by the customer – section 180

Fortunately, section 180 of the Excise Tax Act provides an alternative. Where a non-resident is not registered, an input tax credit for the tax it paid on importation may generally be claimed by its Canadian customer. The customer then reimburses the non-resident. The non-resident must provide to the customer evidence that the tax was paid. This is usually a copy of the customs accounting document.

Initially, a customer who is unfamiliar with section 180 may refuse to apply it. The customer does not believe that it could be entitled to claim an input tax credit for GST paid by someone else. Providing a copy of the section does not help because it applies to other situations that are not relevant here. Further, some of the language is obscure to anyone other than a tax practitioner.

Section 180 is easier to read when you take out the non-relevant portions:

For the purposes of determining an input tax credit of …. a particular person, where a non-resident person who is not registered under Subdivision D of Division V

(a) makes a supply of tangible personal property to the particular person and delivers the property, or makes it available, in Canada to the particular person before the property is used in Canada by or on behalf of the non-resident person,

(b) has paid tax under Division III in respect of the importation of the property …. and

(c) provides to the particular person evidence, satisfactory to the Minister, that the tax has been paid,

the particular person shall be deemed

(d) to have paid, at the time the non-resident person paid that tax, tax in respect of a supply of the property to the particular person equal to that tax.

The term “particular person” refers to the customer of the non-resident. Where the conditions in paragraphs (a), (b) and (c) are satisfied, paragraph (d) “deems” that that the tax paid by the non-resident is paid by the customer. This deeming allows the customer to claim an input tax credit on its GST return.

In my experience, reluctance by a customer to use section 180 may often be resolved by having the importer’s tax advisor communicate with the customer’s tax advisor, who then provides reassurance to the customer.

Russia Sanctions at NATO’s Weakest Point

Map courtesy Bruce Jones Design Inc.

Prior to Covid, the Baltic Sea was a popular cruise destination for travelers from North America and Western Europe.  Saint Petersburg, with its Hermitage Museum and window into the mysteries of Russia, was the highlight for many.

Few people who live outside that region are aware that Saint Petersburg is not Russia’s only port on the Baltic Sea.  There is also Baltiysk, situated further south in the small, isolated Kaliningrad oblast (province) surrounded by Lithuania and Poland.  Kaliningrad is important to Russia militarily, partly because Baltiysk is the home of its Baltic warship fleet.  Cruise ships do not call there. Baltiysk remains free of ice all winter; Saint Petersburg, 600 km. further north, does not.

It is impossible to travel overland between Kaliningrad and the rest of Russia without passing through either Lithuania or Poland and Belarus.  Lithuania and Poland are members of NATO and the European Union.  Belarus is heavily influenced by Russia and an ally in its war against Ukraine. Lithuania became an independent democracy following the dissolution of the Soviet Union in 1991.  At that time, it agreed to allow goods and persons to transit through its territory between Kaliningrad and Belarus via an agreement known as the “Kaliningrad transfer”.

That narrow stretch of Lithuanian territory, just north of its border with Poland, is NATO’s weakest point.  Should Russia decide to extend hostilities to other neighboring states, it would form a tempting target. Success would mean that the Baltic states of Estonia, Latvia and Lithuania, former members of the Soviet Union situated between Saint Petersburg and Kaliningrad, would be isolated from the rest of NATO and the EU.  The other members of NATO, including Canada and the United States, would be obligated by treaty to defend them. 

Shortly before Lithuania joined in 2004, the European Union established rules for the free transit of persons and goods through EU territory between separate parts of non-EU nations. The Kaliningrad transfer has been one of the main uses of these rules, though it has rarely been used for goods since 2004. The tension with Russia that surrounded the establishment of these rules are summarized in this excellent 2020 article from the Lithuanian media.

As part of sanctions against Russia announced on April 8, 2022, the European Union prohibited the road transport of Russian goods within EU territory, including in-transit movements between separate parts of Russia. However, an exception was made for the Kaliningrad transfer (except for goods specifically sanctioned, such as those intended for military, aviation or space use). The fact that the European Union was unwilling to risk provoking Russia by canceling the Kaliningrad transfer along with its otherwise severe sanctions shows how politically sensitive that narrow land corridor has become. As Russia has built up its military presence in Belarus, military experts in North America and Western Europe have called for NATO to bolster its defenses there.

Recently, private donations from Europeans, mainly those in former Soviet or Soviet influenced republics, have been used to purchase military supplies collected in a warehouse in Lithuania and shipped through that corridor to another warehouse in eastern Poland.  The supplies are then transported to defense forces in Ukraine.

I would like to acknowledge the significant contribution that my friend and colleague Enrika Naujoke made to researching this article. Enrika is a director of a customs brokerage firm in Klaipeda, Lithuania and co-founder of the Customs Clear e-learning platform and customs journal.

The Hidden Implications of FTA Origin Audits

Importers who claim preferential tariff treatment under a free trade agreement (“FTA”) are generally familiar with the certificate of origin provided by the exporter or producer of the goods. In most FTAs, importers are required to have this certificate in their possession at the time the preferential treatment is claimed.

Many importers assume that the certificate of origin is the end of the story or that it shields them from liability should the goods subsequently be found not to originate. Unfortunately, this is not the case.

It is the importer who must pay the duties owing plus interest, and perhaps also penalties, should the certificate be invalid. This can come as an expensive surprise. For example, assume a Canadian importer purchases $10 million of goods from a German supplier over four years. They have certificates from the producer which state the goods originate under CETA and are thus duty free. A verification audit determines that the goods did not qualify under the CETA Rules of Origin, and are subject to the MFN rate of 6.5%. The assessment of duties would be $650,000. With penalties and interest, the total bill could be over a million dollars.

Where preferential tariff treatment under an FTA is critical to an importer, they might consider negotiating a provision in the sales contract whereby the exporter guarantees that the goods originate and agrees to pay the duties, interest and penalties assessed if they do not. At a minimum, the importer should take reasonable steps to ensure that the producer has done the work necessary to conclude that the goods originate. They should also review the certificate for “red flags”. For example, a producer who states that a complex piece of machinery is “wholly obtained or produced” in the countries that are party to the FTA likely doesn’t understand origin very well. That category would only apply of every part and all the raw materials in them came from those countries.

The customs authority in the importing country (“Importing Authority“) has the right to initiate the verification or audit of a claim for preferential tariff treatment. This generally begins with the Importing Authority requesting from the importer a copy of the certificate of origin and perhaps other information. If the Importing Authority requires further information, they will contact the exporter, producer and/or suppliers of raw materials to the producer. Under some FTAs, such as the USMCA and CPTPP, this is done directly. For example, the Canada Border Services Agency (“CBSA“) has the right to contact an exporter, producer or supplier in the United States or Mexico to initiate a verification audit under the USMCA. Under other FTAs, such as Canada’s agreements with the European Union (CETA) and the United Kingdom (CUKFTA), the Importing Authority contacts the customs authority in the exporting country, who in turn conducts the verification audit of the exporter, producer or supplier.

A verification audit usually begins with a questionnaire such as Form B231 that was sent by the CBSA to producers in the United States and Mexico where an origin claim under NAFTA was based on tariff shift. When it is published, the corresponding USMCA questionnaire should be virtually identical. A corresponding CETA, CUKFTA and CPTPP questionnaire would be similar. The key information requested is:

  1. a description of the finished good, with product literature and tariff classification;
  2. a description of the production process;
  3. a list of the raw materials, segregated between originating and non-originating, and their suppliers, and
  4. the tariff classification of non-originating raw materials.

A producer who has done the work necessary to substantiate origin should not have trouble completing the questionnaire. It would have kept documentation and analysis in generally the same format. If the customs authority is satisfied that the questionnaire has been properly completed and reached the correct conclusion, the verification audit would likely end there and there would be no adjustment to the duties paid.

An exporter, producer or supplier who receives a questionnaire is not obligated to respond. However, if they do not, the result will likely be an assessment against the importer.

If the exporter, producer or supplier does respond, but the customs authority is unable to conclude from it that the goods originate, it may request a visit of the producer’s production facilities. Again, the producer does not have to consent. However, if they do not the importer will likely be assessed.

Should the importer be assessed at any of these stages, including after a visit by the customs authority to the producer’s premises, they will have the right to appeal.

The CBSA has set out the details of origin verification procedures for NAFTA (predecessor to the USMCA) and other free trade agreements in its Memorandum D11-4-20, and for CETA and CUKFTA in Memorandum D11-4-21. The details for CPTPP have not been published in a Memorandum but are set out in Articles 3.27 and 3.28 to the Agreement.

Restrictions on trade with Russia and Belarus

Effective March 2, 2002, goods originating in Russia and Belarus are denied Most Favoured Nation (MFN) treatment on importation to Canada, leaving them subject to the 35% General Tariff rate. The only other country with this infamous distinction is North Korea.

It is important to note that the 35% tariff applies to goods that “originate” in Russia or Belarus – in general terms. where they are manufactured. Such goods retain their Russian or Belarusian origin status if they are exported to Canada from another country.

The meaning of the term originate is discussed in an article elsewhere on this website. The duty to take reasonable care that the country of origin is correctly declared on the customs documents rests with the importer. You cannot simply rely on a statement from the exporter.

On the same day, Canada prohibited the export and import of goods to or from the so-called Donetsk People’s Republic and Luhansk People’s Republic and the areas of eastern Ukraine that they control. A similar ban has been in place for the Crimea region for some time.

These trade restrictions form part of a series of sanctions applied by Canada both before and after Russia’s invasion of Ukraine on February 24, 2022. A full list of the sanctions can be found on Global Affairs Canada’s website, separately for Russia and Belarus.

Background

MFN is the key privilege of being part of the World Trade Organization. Each member agrees apply the same basic tariff schedule to all of the other 163. Canada was an original member of the predecessor General Agreement on Tariffs and Trade (GATT) in 1947. Russia joined the WTO in 2012 after 19 years of negotiations following the disintegration of the Soviet Union.

Canada is one of many countries that have revoked Russia’s MFN status under the WTO’s national security exceptions, which allow a country to take “any action which it considers necessary for the protection of its essential security interests.” The implications of this action on trade with Russia are different for every country.

The basics of origin in international trade

The concept of origin for goods in international trade can be confusing, for several reasons. First, a good generally originates in the country where it is manufactured, which may not be the country from which it is exported. Second, not all forms of manufacturing confer origin. Third, there are two types – non preferential origin and preferential origin.

Customs duties may vary considerably depending on origin. For example, a pair of soccer boots imported into Canada is subject to duty at 17.5% if it originates in Indonesia but is duty free if it originates in Bangladesh.

Non-preferential origin

Non-preferential origin assigns a home country, or economic nationality, to every good that crosses a border anywhere on Earth. If the good is wholly composed of components or materials derived from a single country, that is its country of non-preferential origin. For example, wheat grown in Canada is of Canadian non-preferential origin, as is multigrain flour milled in Canada using only grains and other ingredients grown in Canada.

It becomes more complicated where a good contains components or ingredients from more than one country. In that case, the country of non-preferential origin is the country where the last “substantial transformation” in production occurs. Each country interprets this principle in a slightly different way.

The United States Customs and Border Protection (CBP) agency states that “substantial transformation means that the good underwent a fundamental change (normally as a result of processing or manufacturing in the country claiming origin) in form, appearance, nature, or character, which adds to its value an amount or percentage that is significant in comparison to the value which the good (or its components or materials) had when exported from the country in which it was first made or grown.”

In its March 2022 publication Guidance on Non-Preferential Rules of Origin, the European Union states that substantial transformation occurs “where goods underwent their last, substantial, economically-justified processing or working, in an undertaking equipped for that purpose, resulting in the manufacture of a new product or representing an important stage of manufacture.”

For the majority of manufactured goods, it is usually clear that a substantial transformation has occurred. The issues occur on the margins where the manufacturing or processing operations are less substantive. Unfortunately, there is no “bright line” test to determine when the threshold has been crossed. In its Guidance publication, the European Union states that the following operations do not confer origin:

  • operations to ensure the preservation of products in good condition during transport and storage (ventilation, spreading out, drying, removal of damaged parts and similar operations) or operations facilitating shipment or transport;
  • simple operations consisting of removal of dust, sifting or screening, sorting, classifying, matching, washing, cutting up;
  • changes of packaging or breaking up and assembly of consignments, simple placing in bottles, cans, flasks, bags, cases, boxes, fixing on cards or boards and all other simple packaging operations;
  • the presentation of goods in sets or ensembles or presentation for sale;
  • the affixing of marks, labels or other distinguishing signs on products or their packaging;
  • simple assembly of parts of products to constitute a complete product;
  • disassembly or change of use; or
  • a combination of two or more of the operations specified above.

In October 2018 the Law Offices of George R. Tuttle, located in San Rafael, California, published an excellent article summarizing the United Sates jurisprudence on the subject of substantial transformation. The article will be useful to anyone struggling with which side of the line their product falls. The following excerpts provide a sense of its substance.

“In recent years Customs and the courts have concentrated on change in use or character of the components or materials when processed into finished goods, and sometimes finding other various subsidiary tests appropriate to consider, depending on the situation at hand. …. Courts have held that when the properties and uses of a product are predetermined by the material from which it was made, no substantial transformation occurs.

“Character” is defined as the “mark, sign [or] distinctive quality” of a thing. …. For courts to find a change in character, there often needs to be a substantial alteration in the characteristics of the article or components. …. Changes that are deemed cosmetic are insufficient for a finding of substantial transformation. 

In analyzing whether there is a change in use, the court has found that such a change occurred when the end use of the imported product was no longer interchangeable with the end use of the product after post-importation processing. …. When the end use was predetermined at the time of importation, courts have generally not found a change in use.”

The Canada Border Services Agency does not provide a definition of substantial transformation. However, they do say in Memorandum D-1-4 that “Certain operations such as packaging, splitting, and sorting may not be considered as sufficient operations to confer origin.”

Preferential origin

Preferential origin refers to the Rules of Origin in a free trade agreement. Canada has many free trade agreements with individual nations. However, the most important agreements are multi-national: the USMCA with the United States and Mexico, the CPTPP with ten nations around the Pacific Rim and CETA with the 27 countries of the European Union.

Where a good is wholly composed of components or materials derived from a single country, that is generally its country of preferential as well as non-preferential origin.  For example, wheat grown in Canada meets the Rules of Origin under the CPTPP when shipped to Japan. Flour milled entirely in Canada from wheat grown in Canada meets the Rules of Origin under CETA when shipped to Germany, and under the USMCA when shipped to the United States.

However, where components or materials originate in countries other than the parties to a free trade agreement, the rules of origin under that agreement are not based on the principle of substantial transformation. Rather, the rules are generally product specific, detailed and often several hundred pages long. These “Product-Specific Rules of Origin” (“PSROs“) follow the Harmonized System (HS) of tariff classification. There are generally three main criteria for qualifying under the PSROs:

  • Tariff shift – a comparison of the tariff classification of the raw materials as they existed before production to the tariff classification of the finished good.
  • Regional value content – in general terms, the ratio of the value of production within the free trade area (e.g., the United States, Canada and Mexico with the USMCA) to the selling price or cost of the finished good.
  • Transformation – a transformation, such as a chemical reaction, that occurs within the production process.

For example, let’s say soccer boots manufactured (and substantially transformed) in the United States are imported into Canada. Some of the raw materials and components originated outside Canada, the United States and Mexico. The boots will be of United States non-preferential origin.

Under the PSRO that includes soccer boots (heading 62.02), the boots will be of United States preferential origin under the USMCA if they meet both a tariff shift test and a regional value content test whereby at least 55% of the cost of the boots must be incurred in Canada, the United States or Mexico. If the boots satisfy both tests, they may be imported into Canada duty-free. If not, the duty rate will be 17.5%.

Common misconception

A common misconception is that goods originate in the country from which they are shipped to the country of import. That is not true. For example, a pair of soccer boots manufactured in Indonesia, shipped to a warehouse in the United States, and subsequently sold to a customer in Canada, remains of Indonesian non-preferential origin. Further, they do not qualify for preferential duty free treatment under the USMCA.

The basics of customs valuation

The term “customs valuation” has a mysterious ring to it, as if it were based on some esoteric, perhaps dark principles. In fact, it is usually fairly straightforward. The valuation of 90% of imports is based on “transaction value”, the price payable on the commercial invoice issued by the exporter.

The trick is to recognize (a) the 10% of situations where transaction value may not be used and (b) where statutory adjustments to the invoice price are required. The situations where transaction value may not be used include where:

  • There is no sale for export (e.g., the goods are leased or have been owned by the importer for some time);
  • The vendor and purchaser are related and the relationship influences the price;
  • There are restrictions on the disposition or use of the goods by the purchaser (other than those imposed by law or geographical area of resale) which substantially affect the value;
  • The sale or price is subject to some consideration or condition with respect to the goods for which a value cannot be determined; or
  • The price cannot be determined.

The rules applicable in these special situations are discussed in Memorandum D13-3-1 published by the CBSA.

Some of the adjustments to the price payable are deductions, while others are additions. Both are often missed. Each adjustment is set out in subsection 48(5) of the Customs Act and described in summary in the CBSA’s Memorandum D13-4-7. There are also separate D Memoranda, referred to below, which discuss each in detail.

The following items are deducted from the price payable if they are included in it; i.e., they are incurred by the seller:

  • Transportation charges, expenses and insurance from the place within the country of export from which the goods are shipped directly to Canada (D13-3-3);
  • Costs for construction, erection and assembly after importation into Canada (D13-3-11);
  • Duties and taxes payable by reason of the importation or sale in Canada of the goods; and
  • Export packing required by the transportation company (D13-3-3).

The following items are added to the price payable if they are not included in it; i.e., they are incurred separately by the purchaser:

  • Transportation charges, expenses and insurance to the place within the country of export from which the goods are shipped directly to Canada (D13-3-5);
  • Amounts for commissions and brokerage, other than fees payable by the purchaser to his agent for the service of representing the purchaser abroad in respect of the sale (D13-4-12);
  • Export packing to market and protect the goods, not required by the transportation company (D13-3-3).
  • Royalties and license fees in respect of the goods that the purchaser must pay as a condition of the sale of the goods for export to Canada (D13-4-9);
  • Subsequent proceeds payable to the purchaser (D13-4-13); and
  • Goods or services supplied by the purchaser for use in the production of the goods, commonly known as “assists” (D13-3-12).

The adjustments to the price payable are summarized in fields 23 to 25 of Form CI1, Canada Customs Invoice. If one or more of these adjustments applies, the importer will usually enter the amounts there.

Canada’s customs valuation rules follow the Customs Valuation Agreement adopted by all members of the World Trade Organization in 1994. The World Customs Organization publishes a useful Brief Guide to the Customs Valuation Agreement, which provides an alternative commentary to the CBSA Memoranda referred to above.

The opportunities of CARM

Photo courtesy rawpixel.com

If you import goods into Canada, you will have heard of the CARM initiative of the Canada Border Services Agency (CBSA). Your broker will be peppering you with emails to encourage you to register at the online portal, post a security bond and begin paying your duties and taxes directly. Unless you wish to account and pay shipment-by-shipment, prior to release, you will be required do these things by early next year. You will no longer be able to use your broker’s security bond or have your broker make payment for you.

CARM is an acronym for CBSA’s Assessment and Revenue Management System. It is designed to give the CBSA a more direct relationship with importers and increase the effectiveness of their audit and enforcement activities. The most positive feature for importers is the opportunity to become more directly involved in the customs process. If you wish, by early 2023 you may file your customs accounting declarations yourself through the CARM portal. The existing Form B3-3 will be replaced by a new electronic form yet to be published. Hopefully, the coding system will be made more user friendly to the importer by drop-down menus and similar tools.

I encourage importers to draft their own declarations for review by their customs broker. This requires some knowledge, which is provided elsewhere on this website in articles on the basics of tariff classification, valuation and origin. Knowledge allows you to better provide to your broker the complete and accurate information that he or she needs to obtain prompt release and avoid unpleasant surprises if the CBSA comes calling later. Online resources available to help you draft your own declarations and customs invoices are described in this article.

If you haven’t registered for CARM, I suggest you do that soon so you can get comfortable the system before you need to use it. You will find all your import transactions and monthly statements of account there now. You may continue to delegate to your broker substantially all customs accounting functions except payment. However, you must take action on the portal do do this.

CARM does not affect the release process. Importers and brokers will continue to provide the customs invoice, cargo control and other release package documents as they have in the past.

Preparing your customs documents using online resources

Importing goods can be intimidating. The customs rules are complex and inflexible, and the forms full of details and coding that appear undecipherable. That is why we have customs brokers. Many importers to assume that, once they hire a broker, they do not need to invest time and energy in understanding customs and trade concepts. That can be a risky approach. Good customs brokers have a lot of knowledge. However, they can put it to good use only if the importer provides them with complete and correct information.

Customs brokers do not have the time to ask a lot of probing questions. They operate in a volume business where the main task is to obtain release at the border. Insufficient or inaccurate information from the importer may result in the goods being misclassified, over- or under-valued or the wrong type or country of origin being declared. This can cause delays in release and/or duty and penalty costs.

To provide proper customs information, an importer needs knowledge. Online resources make acquiring it easier than it used to be. Drafting and submitting your own customs entry documents is becoming easier and more convenient, and provides an excellent way to learn. The broker is always available to answer questions and review the final product.

The importer is responsible for two key documents: (a) the commercial invoice and (b) the customs accounting declaration. The main customs and trade disclosures- tariff classification, valuation and origin – are made on both.

Tariff classification

A useful online tool for tariff classification is the Canada Tariff Finder developed by Global Affairs Canada and two other federal government agencies. Its purpose is to allow one to compare rates of duty for specific goods among countries with whom Canada has a free trade agreement. However, it is also helpful as a place to begin researching the tariff classification of a good. Let’s say you want to classify a bicycle. Under “Find tariff information”, you click on “Importing”, then on a country (I picked the United States) and finally you type “bicycle” under “Describe the product” and click on “Find”. The next screen asks you whether the bicycle is “motorized” or “other”. I clicked on “other”; i.e., a pedal bike. The next screen gives you 5 different options for classification to ten digits under heading 8712 , depending on the size of the wheels. Click on any one and you will learn that the MFN duty rate is 13%, but the bicycle is duty free if it qualifies under the Rules of Origin of the USMCA/CUSMA. The MFN rate would apply if the bicycle did not originate under the USMCA, or if it was imported from a country such as China or India with whom Canada does not have a free trade agreement.

The process is not always that simple. Tariff classification is sometimes complex and obscure. However, the Canada Tariff Finder is generally a good place to start if you haven’t had a lot of experience with the Harmonized System. In all cases, you should review the Customs Tariff, including the section and chapter Explanatory Notes. A more detailed article on tariff classification and the Harmonized system is available elsewhere on this website.

There are many comprehensive reference materials on tariff classification available on the internet. The WCO publishes the HS Classification Handbook, which provides detailed information on the fundamentals of the system. The United States International Trade Commission publishes an online course that takes the reader through all the steps of interpreting the American HTS in about three hours. The examples are excellent. The European Commission publishes its Explanatory Notes to the Combined Nomenclature of the European Union, a 392 page PDF document which provides explanatory notes to many individual tariff items. It goes out to 8 digits, so it includes some tariff item categories unique to the EU, but it is useful everywhere. The system is the same in all countries to six digits.

Adjustments to transaction value

The majority of imports arise from a sale by a non-resident exporter to a Canadian resident importer. Where these two persons are unrelated, the basis of customs valuation will generally be the “transaction value” – the price payable on the commercial invoice prepared by the exporter, expressed in Canadian dollars and adjusted if necessary as described below. If the exporter and importer are related, and the relationship does not influence the price, the basis will also be transaction value.

The adjustments to the invoice price, which are frequently missed, are summarized in fields 23 to 25 of Form CI1, Canada Customs Invoice. If one or more of these adjustments applies, the importer will usually enter the amounts there. Each adjustment is set out in subsection 48(5) of the Customs Act (“Act”) and described in summary in Memorandum D13-4-7 published by the CBSA. There are also a separate CBSA Memoranda, referred to below, that discuss each one in detail.

The following items are deducted from the price payable if they are included in it; i.e., they are incurred by the seller:

  • Transportation charges, expenses and insurance from the place within the country of export from which the goods are shipped directly to Canada (Act 48(5)(b)(i); Memorandum D13-3-3);
  • Costs for construction, erection and assembly after importation into Canada (Act 48(5)(b)(ii)(A); Memorandum D13-3-11);
  • Duties and taxes payable by reason of the importation or sale in Canada of the goods (Act 48(5)(b)(ii)(B); and
  • Export packing required by the transportation company (Act 48(5)(b)(i); Memorandum D13-3-3).

The following items are added to the price payable if they are not included in it; i.e., they are incurred separately by the purchaser:

  • Transportation charges, expenses and insurance to the place within the country of export from which the goods are shipped directly to Canada (Act 48(5)(a)(vi); Memorandum D13-3-5);
  • Amounts for commissions and brokerage, other than fees payable by the purchaser to his agent for the service of representing the purchaser abroad in respect of the sale (Act 48(5)(a)(i); Memorandum D13-4-12);
  • Export packing to market and protect the goods, not required by the transportation company (Act 48(5)(a)(ii); Memorandum D13-3-3).
  • Royalties and license fees in respect of the goods that the purchaser must pay as a condition of the sale of the goods for export to Canada (Act 48(5)(a)(iv); Memorandum D13-4-9);
  • Subsequent proceeds payable to the purchaser (Act 48(5)(a)(v); Memorandum D13-4-13); and
  • Goods or services supplied by the purchaser for use in the production of the goods, commonly known as “assists” (Act 48(5)(a)(iii); Memorandum D13-3-12).

There are a number of circumstances where transaction value may not be used as the method of customs valuation. These circumstances include situations where:

  • There is no sale for export (e.g., the goods are leased or have been owned by the importer for some time);
  • The vendor and purchaser are related and the relationship influences the price;
  • There are restrictions on the disposition or use of the goods by the purchaser (other than those imposed by law or geographical area of resale) which substantially affect the value;
  • The sale or price is subject to some consideration or condition with respect to the goods for which a value cannot be determined; or
  • The price cannot be determined.

The methods of valuation to be used where transaction value may not be used are discussed by the CBSA in their Memorandum D13-3-1. Methods of Determining Value for Duty.

Canada’s customs valuation rules follow the Customs Valuation Agreement adopted by all members of the World Trade Organization in 1994. The World Customs Organization publishes a useful Brief Guide to the Customs Valuation Agreement, which provides an alternative commentary to the CBSA Memoranda referred to above.

Origin

There are two kinds of origin in international trade – non preferential and preferential.

Non-preferential origin

Non-preferential origin assigns a home country, or economic nationality, to every good that crosses a border anywhere on Earth. If the good is wholly composed of components or materials derived from and, if applicable, processed in a single country, that is its country of non-preferential origin. For example, wheat grown in Canada is of Canadian non-preferential origin, as is multigrain flour milled in Canada using only grains and other ingredients grown in Canada.

It becomes more complicated where a good contains components or ingredients from more than one country. In that case, the country of non-preferential origin is the country where the last “substantial transformation” in production occurs. Each country interprets this principle in a different way. As an example, the United States Customs and Border Protection (CBP) agency states that, in its view, “substantial transformation means that the good underwent a fundamental change (normally as a result of processing or manufacturing in the country claiming origin) in form, appearance, nature, or character, which adds to its value an amount or percentage that is significant in comparison to the value which the good (or its components or materials) had when exported from the country in which it was first made or grown.”

The CBSA does not provide a definition of substantial transformation. However, they do say in Memorandum D-1-4 that “Certain operations such as packaging, splitting, and sorting may not be considered as sufficient operations to confer origin.”

The country of non-preferential origin is declared by the importer of record on both the commercial invoice and the customs accounting declaration. Certification of origin is not required.

Preferential origin

Preferential origin refers to the Rules of Origin in a free trade agreement. Canada has many free trade agreements with individual nations. However, the most important agreements are multi-national: the USMCA with the United States and Mexico, the CPTPP with ten nations around the Pacific Rim and CETA with the 27 countries of the European Union.

Where a good is wholly composed of components or materials derived from and, if applicable, processed in a single country, that is generally its country of preferential as well as non-preferential origin.  For example, wheat grown in Canada meets the Rules of Origin under the CPTPP when shipped to Japan. Flour milled entirely in Canada from wheat grown in Canada meets the Rules of Origin under CETA when shipped to Germany, and under the USMCA when shipped to the United States.

However, preferential Rules of Origin for goods containing components or materials originating in countries outside a free trade agreement zone are not based on the broad principle of substantial transformation. Rather, the rules are generally product specific, detailed and often several hundred pages long. These “Product-Specific Rules of Origin” (“PSROs“) follow the Harmonized System (HS) of tariff classification. There are generally two main criteria for qualifying under the PSROs:

  • Tariff shift – a comparison of the tariff classification of the raw materials as they existed before production to the tariff classification of the finished good.
  • Regional value content – in general terms, the ratio of the value of production within the free trade area (e.g., the United States, Canada and Mexico with the USMCA) to the selling price or cost of the finished good.

Commercial invoice

The commercial invoice is exactly what the name implies – the invoice sent by the exporter to the importer as the basis of payment. It is one of two key documents provided to the CBSA prior to release. The other is the cargo control document, or manifest, prepared by the carrier.

The customs regulations specify that the commercial invoice contain certain prescribed information set out in paragraph 43(b) of the CBSA’s Memorandum D17-1-4, Release of Commercial Goods and on Form CI1, Canada Customs Invoice. Instructions for providing this information are set out at Appendix A of Memorandum D1-4-1, CBSA Invoice Requirements.

In addition to tariff classification, valuation and non-preferential origin declarations discussed above, the the commercial invoice includes the following prescribed information:

  • Details of the sale or other transaction giving rise to the import (vendor, purchaser, consignee, conditions of sale, terms of payment and currency of settlement);
  • Details of the shipment (date and place of direct shipment to Canada, mode of shipment and, if applicable, country of transshipment); and
  • Description of the goods, including quantities, weight and references to package markings and contents.

To provide complete third party evidence of the terms of the underlying sales contract, the CBSA would prefer that the commercial invoice be prepared entirely by the exporter. However the importer often has to add certain information, either on a separate page or on Form CI1.

Customs accounting declaration

The main purpose of the customs accounting declaration is to calculate the duties and taxes owing. Where the importer or broker has provided security, it is submitted after release. Much of it is a coding exercise that repeats the substantive declarations made on the commercial invoice. The coding takes awhile to get used to but once you do it is fairly straightforward. Instructions are available on the CBSA’s Memorandum D17-1-10, Coding of Customs Accounting Documents.

As part of the CBSA’s new Assessment and Revenue Management (CARM) online system, importers will be able to file their customs accounting declarations directly to the CBSA starting in the spring of 2022. The existing Form B3-3 will be replaced by a new electronic form. It is likely that the currently awkward coding system will be made more user friendly to the importer by drop-down menus and similar tools.

Calculation of duties

Duties are calculated by applying a particular “tariff treatment” to the tariff classification of a good. Tariff treatment is determined by origin, either non-preferential or preferential. The tariff treatments available for each country of origin are published by the CBSA in a Schedule. There is not enough space in this article to explain tariff treatment completely. However, we can summarize the main points. The Most Favoured Nation (MFN) treatment is available to substantially all countries. The main notable exception is North Korea. The General Preferential Tariff (GPT) and Least Developed Country Tariff (LDCT) generally provide rates of duty lower than MFN for goods originating in the world’s developing nations. The “Other” column in the Schedule includes other preferential tariff programs (for example, the Commonwealth Caribbean Countries Tariff, or CCCT) and the treatments that apply where goods originating in a country with whom Canada has a free trade agreement satisfy the Rules of Origin under the agreement. The main free trade agreement tariff treatments include:

  • United States Tariff (UST) – USMCA/CUSMA
  • Mexico Tariff (MXT) – USMCA/CUSMA
  • Canada-European Union Tariff (CEUT)
  • Comprehensive and Progressive Trans-Pacific Partnership Tariff (CPTPT)

The duty rates applicable to each tariff treatment in each item of tariff classification are set out in a Schedule organized by Chapter of the Harmonized System. Where more than one tariff treatment is available to a country, the importer may choose the most advantageous one. For example, all countries with whom Canada has a free trade agreement also qualify for MFN treatment. Where goods are duty free under MFN, the importer will usually choose that treatment, as there is no point in doing the work to determine whether the goods meet the Rules of Origin. Where goods are dutiable under MFN and meet the Rules of Origin, the importer will usually choose the free trade agreement category to save the duty.

Goods and Services Tax (GST)

Most commercial goods that enter Canada are subject to the federal goods and services tax (GST), a value added form of sales tax. The current rate is 5% of the value plus any duties. The major exceptions are certain basic groceries, prescription drugs and biologicals, medical and assistive devices and products of agriculture and fishing. The full list of exceptions may be found in Schedule VI and Schedule VII to the Excise Tax Act.

For most business inputs such as raw materials, capital equipment and goods acquired for resale, this GST is recoverable as an input tax credit on the importer’s GST return filed monthly, quarterly or annually. However, importers involved in certain businesses (for example: financial services, rental of residential real estate, health care and education) may not be able to recover the tax, or may be able to recover only part of it.

The Customs Challenges of Importing by Pipeline: A Proposed Solution

The transportation of natural gas, crude oil and other liquids by pipeline has unique attributes that make customs reporting and accounting difficult, and easy to miss altogether. A pipeline is buried in the ground, out of sight and mind. The hydrocarbons continue moving to their destination as if the border does not exist.  Crude oil and other liquids move in consecutive batches, like rail cars on a train of infinite length. Natural gas moves in a continuous stream, with all shippers’ goods commingled. A shipper does not own any particular molecules in the stream, and takes instant delivery of different molecules than it put in.

All hydrocarbons imported into Canada by pipeline are duty free regardless of origin. They are subject to GST (unless in-transit through the United States); however, that tax is recoverable as an input tax credit by substantially all importers. There are no “admissibility” issues. It is difficult to smuggle narcotics, used mattresses or firearms in a batch of crude oil.

The legal obligation to account for imports by pipeline is the same as it is for imports by other means. Under section 17 of the Customs Act, the duties and taxes remain an in rem charge on the goods until someone takes responsibility to account for and pay them. The primary liability rests with the importer of record – the person who arranges for release. The owner at the point of release is jointly and severally liable. 

The identity of the importer of record is not specified in the Customs Act the way a taxpayer is in the Income Tax Act or Excise Tax Act.  Rather, the importer of record may be anyone with an interest in the import of the goods who comes forward to accept the obligations associated with importation, in return for obtaining release.

It is physically impossible to release goods imported by pipeline using the normal shipment-by-shipment process.  Consequently, there is currently no mechanism in Canada for the importer of record to be identified before a shipment enters the commerce of the country.  The CBSA allows importers to account for importations by pipeline on a monthly basis following importation.  Where this happens, the identity of the importer of record becomes clear after the fact.  However, if reporting and accounting do not happen, how does the CBSA determine the importer of record, and therefore liability?

To illustrate the problem, let’s assume that a Canadian marketing company purchases a batch crude oil in the United States from an American seller and resells it for delivery to a refinery in Ontario.  Either the marketing company or the refiner could act as importer of record.  If neither files the monthly accounting entry, and their contract is silent on the responsibility for customs entry, who has the primary liability under section 17?  Could joint and several liability be enforced against one of them as owner when release does not occur?

The situation becomes more complicated as more persons become involved.  What if the marketing company delivers portions of the batch to two different refinery customers?

The issue is more complex still with natural gas.  An importer does not own any particular molecules in the commingled stream, and the size of its contractual right to a portion of the stream varies as it buys and sells gas while in the pipeline.  Further, imported gas is generally commingled with Canadian gas before it is delivered.

Fortunately, our American neighbours provide a model to show us how we might approach these issues.

The American Approach

The American policy for imports by pipeline is based on a U.S. Customs and Border Protection (“CPB”) policy called the Monthly Consolidated Entry of Non-Dutiable Merchandise Procedure (“Monthly Entry Procedure”) published in 1970.  This policy provides for the optional filing of monthly entries to cover high volume repetitive shipments (at least 2 per week or 7 per month) of duty-free goods.  The shipments must be consigned by one carrier to one importer through one port.  Importers who do not use the Monthly Entry Procedure must file daily entries.

An importer wishing to use the Monthly Entry Procedure makes application to the director of the port.  The format of the application must include the following information.

  1. A detailed description of the merchandise to be shipped.
  2. The identity of the seller and importer and their business relationship.
  3. The points of origination of the goods.
  4. Copies of pertinent orders, instructions and correspondence between the shipper and importer including an indication of the expected volume and number of shipments per month.
  5. Sample copies of documents which will be employed under the monthly entry procedure.

If its application to use the Monthly Entry Procedure is accepted, the importer files a consolidated entry within 10 days from the end of each calendar month.  Unlike other carriers, pipeline operators are not required to present manifests or packing lists at the time of importation.  However, they are required to keep records and make them available to the CPB.  A manifest is filed by the importer of record with the consolidated monthly entry.  This may be done on a spreadsheet.  Pipeline operators must provide facilities through which the CPB may sample the goods being imported.

In 1992 and 2006, the CPB issued instructions to their district offices to inform importers by pipeline, particularly natural gas importers, of their reporting responsibilities, and the penalties, civil and criminal, they might face for ignoring customs laws.  The fact they had to do this indicates that non-compliance for pipeline importations remained a significant problem. 

The key feature and advantage of the American approach is that it requires someone to commit to being the importer of record before an importation occurs, making it clear who has the related customs liabilities.  If the entries are not made, or questions need to be answered, the CBP knows who to contact. 

A potential Canadian Solution

A similar system could be established in Canada.  The key to success would be regular tracking and follow-up by the Canada Border Services Agency (“CBSA“).  They would have to register importers and their proposed transactions, check carriers’ records regularly for any unregistered transactions and check and review the entries made against registered transactions.  This would involve some additional work, but likely much less than is involved in the normal monitoring and releasing of imports by other means.

As far as I am aware, the CBSA has paid limited attention to imports by pipeline for many years.  This is a comfortable situation for importers as long as it persists; however, the situation is dangerous for both importers and the CBSA.  While an assessment of GST would generally be recoverable as an input tax credit, the related interest would be a cost unless waived by the CBSA.  The penalties for failure to report and account for imported goods can be significant – anything up to the full value of the goods.  However, there may be some question whether a court would uphold such penalties when the mechanism for assigning liability at the point of importation was not present.

Should the CBSA adopt a policy akin to the one outlined above, the approach should be to bring all importers into compliance without assessing penalties or interest, until the process had been operating for some time and is generally understood.