U.S. Customs 

  U.S. Customs has once again refashioned its audit process.  Compliance Assessments have now been replaced by Focused Assessments.  Focused Assessments are designed to reward certain types of company practices to a much greater degree than the now defunct Compliance Assessment.

   But Focused Assessments are still audits conducted by the Regulatory Audit Division of U.S. Customs.  They are still designed to protect the U.S. revenue, to collect loss of revenue, and to support penalty and other enforcement measures.  The Focused Assessment method is also new, both for Customs as well as importers and their representatives.  Therefore, the proper procedures to be followed and the direction or findings of any given audit needs to be considered carefully.

   We currently represent an importer undergoing one of the first Focused Assessments conducted.  They were actually selected to be the subject of a prototype Focused Assessment.  We are pleased to report that this audit, while going on intermittently for over a year, has been non-adversarial thus far.  The importer was found to be lacking in certain areas and is therefore obliged to implement new internal controls and compliance systems.  Customs will return after six months and judge whether the importer has improved satisfactorily. Because of this new Focused Assessment model there is potential for an audit to consume several years, periods of which are dedicated to internal self-improvement for the importer subject, and periods of which are review and evaluation by Customs.  Like Compliance Assessments before them, Focused Assessments require substantial time and effort of an importer.

   The biggest difference between the new Focused Assessments and Compliance Assessments is that in Compliance Assessments, Customs always reviewed a statistically relevant sample of transactions for compliance.  In Focused Assessments, Customs might not review a statistical sample of transactions if it is satisfied that the importer’s internal controls are adequate and there is little risk of noncompliance and attendant loss of revenue.  Importers are accordingly encouraged by the Focused Assessment program to enhance internal controls with a view to avoiding more intensive audit activity. 

   Like the other forms of Customs audit before it, a Focused Assessment begins with written notice to the importer.  The time between the notice and the commencement of the Customs audit is usually long enough for the importer to conduct self-assessment activities and to prepare prior disclosures if necessary.  (Prior disclosure is a feature of the civil penalty statute, 19 U.S.C. § 1592, which provides substantial penalties for material false statements or omissions due to negligence, gross negligence, or fraud.  If the importer discloses the circumstances of a violation prior to or without knowledge of the commencement of a penalty investigation, the penalties are substantially curtailed.  In the case of gross negligence or negligence, when a valid prior disclosure is made, penalties are limited to an amount equal to interest on the loss of duties from the time of liquidation to the time of payment).

   Within a reasonable time after the notice, Customs conducts an entry conference at the importer’s premises to describe and commence the process.  Customs is represented in the audit by one or more regulatory auditors and a Customs import specialist all of whom attend the entry conference.  The first phase of the audit is called the Pre-Assessment Survey.  In addition to data that Customs will gather on its own about a subject company’s imports, Customs also requests that the importer complete a comprehensive questionnaire about its Customs business.  This questionnaire places an overwhelming emphasis on the presence of internal controls for Customs compliance.  We have seen few importers that have internal control systems in place to satisfy the extensive demands that appear to be required by the Focused Assessment questionnaire.

   For example, our client that is currently undergoing the Focused Assessment has many knowledgeable people in charge of import purchasing, utilizes a very good Customs broker to file its entries, and is an ISO 9001 company.  However, these characteristics or practices were not considered sufficient internal controls to satisfy Customs’ inquiry in the Pre-Assessment Survey, which is essentially whether the subject company has documented internal controls in place to foreclose material risk of noncompliance. 

   Regardless, the new Focused Assessment approach, the basic areas of risk and compliance that Customs examines are the same:

   •Whether the importer classifies imported merchandise correctly.

   •Whether the importer values imported merchandise correctly.

   •Whether the importer meets the requirements of any special programs affecting its importations or under which it claims preferential benefits, such as NAFTA and assembly of U.S. components abroad.

Recordkeeping

   In the Pre-Assessment Survey phase of the audit, Customs may engage in limited and directed transaction sampling.  In our recent experience, Customs allowed us to have input in the limited sampling selection, and we were successful in excluding certain types of entries that we contended were not typical or representative of the company’s imports. 

   The limited transaction sampling is utilized as part of the Pre-Assessment Survey and is intended to test areas in which Customs has determined that risk exists because of insufficient controls.  From our experience, and based on the high level of controls necessary to preclude risk from Customs’ perspective, it is likely that limited transaction sampling will occur in any Focused Assessment.  The conclusions reached by Customs as a result of this limited testing and the Pre-Assessment Survey determine the further direction of the Focused Assessment.

   If Customs identifies no areas of risk and concludes that the company’s internal controls are adequate, then the audit ends with a designation of low risk.  If compliance risks or loss of revenue are identified, Customs may invite the company to implement a Compliance Improvement Plan.  If the company agrees, Customs will assign a standard risk designation with the understanding that auditors will return in six months to test whether the CIP successfully reduced the risk of noncompliance.  If the company refuses to implement a CIP, or if the loss of revenue cannot be adequately quantified based on the limited sampling, the Focused Assessment will move into the Assessment Compliance Testing phase in which significant transaction sampling will occur. 

   If possible, many companies will seek to avoid more extensive transaction sampling to avoid discovery of unknown errors and related loss of revenue as well as the additional strain that it places on personnel to retrieve records and respond to continuing auditor inquiries.  Indeed, we would generally recommend taking whatever action necessary to avoid additional sampling because of an interest in concluding the audit.  However, agreement to implement a CIP and the additional future audit scrutiny that comes with it also presents difficulties for a subject company.  

   There is the difficult task of devising a useful CIP and then mobilizing company personnel, including those in management, to implement it promptly and ensure that it functions to prevent the type of risk identified by Customs.  If the CIP is not implemented or is not effective, and Customs returns to find that the risk remains, the company could end up being the subject of Assessment Compliance Testing.  Thus, a Focused Assessment has the potential to go on for many years in that a company, once selected, may expect to be under the scrutiny of auditors until a determination of low risk is made.

   The compliance issues that we most frequently encounter  in audits, self-assessments, and general compliance counseling include:

   •Failure to account for and pay duty with respect to “assists” (i.e., components, tools, molds, engineering, and certain other items furnished to foreign suppliers for free or at reduced cost).

   •Failure to account for indirect payments, commissions, royalties, and other dutiable increments of value that are not shown on the commercial invoice.

   •Failure to properly  account for or document nondutiable costs, such as international freight and insurance.

   •Misclassification of merchandise due to incorrect use of the tariff schedule or inadequate descriptions on invoices and other documents.

   •Failure to support claims under special trade programs, such as NAFTA, that require the importer to monitor and document value content, tariff shift, or other qualifying conditions.

   •Inadequate claims for duty free treatment of U.S. goods returned or U.S. components assembled abroad.

   •Failure by related parties to demonstrate that transfer prices are established at arm’s length.

   The audit experience presents various difficulties and risks to the importer, including:

   •Expenditure of time, effort, and resources in the lengthy audit process.

   •Possible claims for additional duties and penalties.

   •Possible expansion of the audit from one year to five years (the period of the applicable statute of limitations).

   •Disagreements with Customs on sampling methodology, particularly “projection” of loss of revenue from the sample to the universe of all affected transactions.

   •Disagreements with Customs on the merits regarding issues of classification, value and other areas of the applicable law.

   •Varying levels of expertise, training, experience, and aggressiveness among Customs personnel and offices.

   At the conclusion of the audit, including at the end of the Pre-Assessment Survey when a standard risk designation is granted based on an agreement by the importer to implement a CIP, Customs prepares a written audit report and gives the importer the opportunity to submit its comments.  Depending on the contents of the report and the stage that the report covers, the importer’s comments may be an important mechanism for preserving a balanced record of the process and findings.

   According to the level of risk or noncompliance determined by Customs in its report, the importer’s activities are ostensibly subjected to greater or lesser Customs attention on an ongoing basis following the audit.

Jason Waite is an attorney with Alston & Bird LLP. He practices customs and international trade law and can be reached at jwaite@alston.com or at (202) 756-3300.