Customs is among the oldest professions in the world and often one of the most powerful government agencies with the characteristics of a tax authority, police, trade regulator, and transport regulator. The previous chapter discussed how customs needs to adapt to assume increasing roles in some areas while retaining its core roles, notably revenue collection. This chapter focuses on the changing global environment concerning trade and transport as well as evolving policies and practices regarding taxation, trade, investment, and customs valuation, all affecting customs revenue collection.
Global Environment Concerning Trade and Transport
The previous chapter discussed “slowbalization” of international trade, which has implications for customs’ revenue collection regardless of the types of duties and taxes levied. Insofar as these taxes are based on the import value, customs administrations should be aware that revenue collection may not increase as fast as it did previously (unless a new tax on imports is adopted, such as the carbon border tax discussed later in this chapter). Indeed, the percentage of revenue collected by a customs administration to GDP in the longer term may decline for as long as import growth is slower than GDP growth, and the speed of decline would be accelerated as the capacity of domestic tax administration increases and the compliance of domestic taxpayers improves.
“Customs’ contribution to revenue will continue, but customs’ tax base growth may slow, and its share of GDP may decline if no other new tax is collected by customs.”
Transport Patterns: More Clearance Away from the Borders1
International transport business has evolved significantly in terms of concentration and hub-and-spoke. This sector is typically characterized by economies of scale: larger companies tend to have greater bargaining power and capacity to mobilize bigger ships and collect larger volumes of cargoes, they can afford to invest in back-office capacity and ICT, and they are able to provide multimodal transportation and pertinent services. In recent years, the international seaborne container carrier business has become increasingly concentrated. The top 10 operators’ share is more than 80 percent of the world’s total capacity (Jensen 2019). These operators can reduce their freight costs significantly by investing, for example, by mobilizing bigger ships, including the “Panamax class,” whose size is such that they cannot pass through the Panama Canal. Since few ports in the world can accommodate Panamax-size ships, the transport pattern has changed from point-to-point to hub-and-spoke, whereby larger ships/larger companies connect between regional hubs and smaller ships/smaller companies connect between the regional hub and the final destination. From the global perspective, hub-and-spoke is less costly than point-to-point, not just because of scale economies and room for investment in terms of size of ships and companies but also because the point-to-point may face greater risks of empty one-way traffic, operate less frequently, and face less competition.2 Containers are rentals from the seaborne transporters that would charge extra for a late return. Therefore, an empty container has to be returned to these companies in one of the regional hubs or their regional logistics center.
Transshipment at the regional hub has become a regular business practice.3 Many regional hubs provide special economic zones (SEZs) for certain value-adding operations on cargoes (for example, cleaning, packaging, labeling, and processing). Transshipment and processing at regional hubs, particularly if it is a free zone, may impair cargo traceability. As hub-to-hub shipments are handled by large and modern companies, data compilation and data exchange are feasible. However, feeder transporters are smaller, often protected by national regulations, and often lacking investment in ICT and business process reengineering; the customs administration may have difficulty obtaining the manifest, cargo, and consignment data electronically and on time.
Seaborne transport ships are getting larger, and the carriers are becoming more sensitive to the costs, the largest cost element coming from the ship dwell time at the port. The shorter the ship dwell time, the more profit the transporter can earn; the same applies to the port authority, in that the shorter the ship dwell time, the more ships can come and the more profit it gains. Within the ship dwell time, the largest component is the cargo charging/discharging time, in which, among other attributes (for example, logistics professionalism and customs performance), congestion in and around the port is significant. Because many ports are located in urban areas, it is extremely difficult to enlarge the port site; therefore, more countries have developed inland clearing depots, moving customs clearance away from the port. Certain countries adopt a mixed approach: full-load-container (FCL: the same shipper-seller’s goods in a container, handled by seaborne transporter) can be cleared in the port, while less-than-full-container (LCL: several different shippers-sellers’ goods are in a container, handled by the cargo forwarder) must be transferred to the inland clearing depot where the goods will be declared and cleared. A similar trend is observed in landlocked countries that are creating dry ports away from the land border and closer to large cities. Transportation between the port/border post and the inland clearing depot is usually treated as bonded transit transportation, which incurs a transit diversion risk. There are several mitigation measures for this risk (for example, transit bond/guarantee, start/destination comparison, itinerary control, cargo tracking devices, customs seal, customs escort, convoy, and so on). In some countries, rail transportation and/or specially authorized road transport operators exclusively handle such transportation, which may reduce the transit diversion risk, thus requiring less customs control.
“Through inland clearing depots, more imports may be cleared away from the borders, increasing the need of customs transit management.”
Trade Patterns: Increased Challenges for Customs Administration
Intra-Firm Trade and Related Parties
More than half of world trade is thought to involve intra-firm trade.4 Intra-firm trade occurs through global value chains (GVCs)—long and complicated world-wide networks for the production of goods and services, whereby intermediate goods cross at least one border, and typically many borders, in pursuit of efficiency gains before final assembly. The most recent figures available show that GVCs covered 70 percent of world trade, as services, raw materials, parts, and components cross borders before being incorporated into final goods that are shipped to consumers all over the world.5 Multilateral enterprises have deliberately diverted sources of materials and parts and allocated several functions and production lines, even for the same product model, in different countries. This decision is the result of lessons learned from the increased incidence of international supply chain disruptions, notably natural disasters, but also other country risks. Assembled products are transferred to distribution centers and final sales points, all of which could be under the same corporate group. Such trade may not be in the form of a usual international sales transaction when there is no seller and buyer—goods may be simply transported from one place to the other place coincidentally in a foreign country—thereby making customs valuation difficult. Profit shifting through transfer pricing may occur during this business transaction, and corporate income tax could be severely affected.
“Customs administrations should be attentive to not only unit value but also the seller–buyer relationship in customs valuation.”
Similarly, international supermarket chains transfer thousands of items cross-border from one distribution center in a country to a distribution center in a different country. A truck can carry thousands of different items with different origins without original invoices. For this, customs clearance is so complicated that it may need innovative procedures, such as clearance based on audit or periodic delectations granted to an authorized economic operator (AEO) in certain countries.6
A traditional customs clearance procedure requests supporting documents, notably packing list, invoice, and manifest (summary of bill of lading [B/L]). The B/L is regarded as important as it is the document of title to the cargo issued by a third party (maritime transporter) and checked by another third party (commercial bank) through the trade financing based on letter of credit (LC) (see Box 2.1).
Trade Financing by LC and B/L
1. The risk of the seller (exporter): it ships the cargo but does not receive the payment. The risk of the buyer (importer): it pays the amount but does not receive the goods.
2. A solution has been used since the 19th century, where
a. The buyer opens an LC in its bank.
b. The seller and buyer conclude the international trade sales contract.
c. The buyer’s bank issues the LC to the seller.
d. The seller ships the cargo to the carrier; in exchange, the carrier issues a B/L.
e. The seller provides the B/L to its bank; in exchange, the bank pays the amount.
f. The seller’s bank provides the B/L to the buyer’s bank; in exchange, the buyer’s bank pays the amount.
g. The buyer’s bank provides the B/L to the buyer; in exchange, the buyer pays the amount.
h. The buyer presents the B/L to the carrier; in exchange, the carrier releases the cargo.
3. The LC specifies what documents must accompany the B/L; these are usually necessary documents for customs and other clearance in the importing countries, that is, commercial invoice, packing list, insurance policy, and, if needed, certificate of origin, export quarantine certificate, technical standards conformity certificate, laboratory test result, and so on. The banks scrutinize them to determine if they are the ones specified in the LC.
Trade financing using LC functions only when the country’s banking sector is internationally accepted. Certain countries’ banking sectors—for example, those in fragile and conflict-affected states (FCS)—are very weak and not recognized internationally; thus, the traders of such countries cannot benefit from this trade financing method. The document called B/L may be issued, but it no longer represents the title document of the goods; it is just a transport service contract. Such traders have to take the risk of using the importer’s agent in the exporting country or the exporter’s agent in the importing country. When using the importer’s agent in the exporting country, the buyer’s agent is the exporter and the buyer is the importer; when using the exporter’s agent in the importing country, the seller is the exporter and the seller’s agent is the importer. In these cases, international trade between two such parties may not be a normal sales transaction; the invoice and B/L between the importer and exporter may not contain the actual trade transaction value. The actual trade transaction value would be either the one the buyer’s agent bought in the exporting country from the seller or the one the seller’s agent sells in the importing country to the buyer (after the clearance/ release). Customs administrations should be attentive to not only unit value but also the seller–buyer relationship in customs valuation.
Small/Expedited Shipments: E-commerce
With e-commerce, small value/expedited shipments have grown very rapidly, and this trend is augmented under the COVID-19 situation. This includes where international road transportation experienced severe conditions (for example, closure of the border posts, trucks and cargo can cross the border while drivers are not allowed). Air transportation may be the best second choice to replace international road transportation. Air transportation has one constraint in that its airway bill is not a title document of the goods but is a transport document in which the goods’ value information is indicative and not checked by the third party (for example, a bank). Worse, the e-commerce business model often separates the two work streams: sale of the goods (seller–buyer) and transportation of the goods (seller [consignor] and carrier [consignee]), which are salient characteristics of a small/ expedited shipment. A few countries limit the number of such e-commerce service providers, which are obliged to share the sales information with the customs administration. Most customs administrations may receive transport documents but not sales documents. Revenue collection on e-commerce is still in a learning phase. The international customs community, notably the WCO, advises that customs administrations, working with appropriate agencies or ministries, should consider applying various types of models of revenue collection (for example, vendor, intermediary, buyer, or consumer, and so on) for duties and/or taxes.7 Although the scope is limited to value-added tax (VAT), there are countries that VAT on low-value import is collected by tax administration, directly from the vendor or intermediary in the exporting countries, in collaboration with customs administration (Brondolo and Konza 2021).
“Growing e-commerce, particularly low-value shipments, reveals challenges on several fronts, including VAT collection.”
For certain countries, clarification and/or review of the “personal use” definition (goods for personal use may be waived from duty8) is needed as it is vague and de minimis level (on customs duties and on VAT) may not be provided. Many countries set a certain quantity or value of imports as a threshold by which trade needing a formal import declaration is distinguished from trade subject to a simplified report. There are instances of traders dividing one large shipment into many small lots to evade commercial trade obligations. Customs staff need the capacity to detect such traders’ duty evasion efforts.
The de minimis approach also attracts global debate. One can argue that in order to promote digitalization, the duty on e-commerce related to small value/ expedited shipments should be waived and de minimis level be increased; one can also argue that de minimis, particularly that of VAT on imports, undermines the competitiveness of domestic industry (not necessarily the manufacturers but also domestic retailers) and therefore should be abolished.9 The original concept of de minimis is that if the cost of collecting tax exceeds the amount of collected tax, it should be waived. Following this concept, if new technology or techniques are invented to collect tax in a less costly manner, the tax should be collected.
Sharing of experiences on the issues above has started and key lessons learned have been compiled by the international customs community (WCO 2018). Standards have been developed on the following eight thematic areas: advance electronic data and risk management; facilitation and simplification; fair and efficient revenue collection; safety and security; public–private partnerships; public awareness, outreach, and capacity building; measurement and analysis; and leveraging transformative technologies.
Trade in Secondhand Items
The internet’s ease of sharing information allows parties to resell goods instead of discarding them. The resale of secondhand items has increased even in crossborder trade, from small items to big items, such as manufacturing machinery, trains, aircraft, and ships. The creation of new HS classifications for worn clothing and used pneumatic tires is evidence of the growth in this trade.
It is highly likely that secondhand products’ duty rates or regulations may differ from those applied to new products. Customs needs to distinguish between new and secondhand products. Furthermore, the rules of origin of secondhand products need careful attention in terms of differences in trade statistics and regional trade agreement (RTA)10 application. Accordingly, secondhand items offer challenges to the customs officer: to assess whether they are secondhand, to identify the goods’ origin, and to determine if the associated duty rate and necessary certificate are different.
Trade in Mixed Goods/Intangibles
More companies are seeking income through subscription business models11 rather than lump-sum goods sales. Moreover, digitalization may characterize the goods after downloading the software/application. If the goods’ value relies on such services or intangibles, the concept of customs valuation may face challenges. Mixed goods/intangibles are not necessarily new. In the past, a WCO Technical Committee on Customs Valuation advised on the customs valuation for portable media of audio/visual assets. Trade in master film for theater and detailed blueprint paper of large construction projects can be examples. A goods/service mixture can also be found in leased goods; the lease is a service activity and does not charge for the leased goods but on the right to use them. For example, leased goods can qualify for temporary duty suspension, but there are cases where the lease contract was extended several times and years; hence duty suspension is extended too. In the future, the evolution of business models will create more complicated cases. So far, a mobile phone device is charged customs duties. Yet, for example, if someone starts a business with secondhand mobile phones and gives them free of charge to foreigners to make a profit through data usage on these phones, the question is if the goods have a fixed value or if the value is for pure service. Another challenge is posed by the emergence of new intangible technologies, such as 3D printing (as indicated in Chapter 1). With the consequent shortening of GVCs, the digital data blueprint will likely take up a greater portion of the value of a product, which in the past would have been fully taxed by customs when crossing borders as a tangible product. As a result, tax and customs administrations may attempt to replace lost tax revenue by taxing the digital or intangible service flow and thus put such companies under greater scrutiny.
“Increasingly goods are value-added by services and intangibles; trade in such mixed goods/intangibles raises challenges for customs valuation.”
Manufacturing processes, if conducted on a fee or contract basis, are considered a service under WTO rules. Such services are included in the General Agreement on Trade in Services (GATS) Sectoral Classification List that has been generally used by WTO members to schedule their specific commitments in services under the GATS. Whenever an economic entity performs such functions, the GATS rules apply. As a result, a different set of trade rules—trade in goods or trade in services— applies to otherwise identical operations and the resulting products, depending on who owns the inputs and outputs. Thus, structural differences between GATT and GATS could be used by economic operators to circumvent trading partners’ use of GATT-based tariffs (and trade defense instruments, especially anti-dumping and countervailing duties). Given increasing size of manufacturing services in the commercial activities, a number of statistical offices now provide relevant data concerning “manufacturing services” despite the conceptual complexities involved.12
These issues need an internationally harmonized approach. Customs administrations should engage in the international study and policy formulation dialogues, which would facilitate familiarization with the topic, the different options, and other countries’ efforts and lessons learned.
Data-driven business models are accelerating, becoming critical to everything from manufacturing to services, some of which involve cross-border exchange. According to an IMF blog (Lagarde 2018), “Recent trends on global trade have tended to focus on protectionist measures and diplomatic tensions… Yet what is often lost in the current discussion is that we are entering a new era of trade.
Tax Policy
Taxes and Customs Administration’s Collection Role
Value-Added Tax
As indicated in Chapter 1, a key evolution in tax policy in the world has been the introduction of VAT. VAT is promoted by the IMF as it is theoretically more growth friendly because it is neutral to business and arguably less harmful to economic competitiveness than excises and customs duties.13 VAT is assessed at every point along the value chain, including importation. VAT on imports is usually collected by customs administrations at the time of import clearance, which can be regarded as a withholding tax (Keen 2007b),14 whereas VAT on value addition in the domestic market is collected by the tax administration. In many countries, VAT paid during production will be refunded at exportation (export VAT refund), which is usually handled by the domestic tax administration.
Customs’ VAT collection is imperative to countries, particularly those having weak domestic tax administration or low domestic tax compliance. The share of customs’ VAT collection in relation to net VAT revenue is diverse, depending on the respective size of imports and exports vis-à-vis GDP, the capacity of domestic tax administration collection for VAT, and the national industry structure; the average share of customs’ VAT collection in VAT collection in low-income countries is 40.3 percent and that of emerging markets is 53.7 percent (see Chapter 1, Box 1.1). In the longer term, however, when the domestic economy, particularly the service sector, becomes stronger and the value addition by the domestic economic activities increases, the size of imports to the GDP declines, as does the share of customs’ VAT collection in relation to the net VAT collection.15
VAT and Customs Administration
Many customs administrations consider that VAT collection is no more difficult than customs duties collection, which may underestimate the challenges (Keen 2007a). The reality of VAT in countries, particularly in low-income countries, is different from what the IMF may advise— single flat rate, broad VAT base, no/little exemption, or zero rating.16 Also, it appears different from the theory, for example, VAT is less vulnerable against lower-value import declaration because such margins would be captured at a subsequent point in the value chain and charged accordingly; and all the goods are retained under customs’ supervision until the duty/ tax is paid. The reality creates several challenges to customs administration in VAT management. The major ones with possible mitigation options are the following:
“Customs may underestimate the impact of VAT on imports and the risk associated with VAT management.”
Importation can be the final moment where VAT can be collected, for example, import is the final consumption. A low VAT threshold in the domestic economy and low compliance of taxpayers in the domestic value chain can lead to lower-value import declarations and the risk of revenue leakage regardless of whether the goods are subject to customs duty or are duty free. Customs needs to review the selectivity criteria for valuation, which may be based on risks related to customs duty and excises but not to VAT.
VAT has multiple rates and exemptions and zero rating are granted to certain commodities. This creates a risk of tariff classification slippage to exempt or lower/zero rates. Again, customs needs to review the current selectivity criteria for classification determination, which may be based on risks related to customs duty and excises but not to VAT.
Certain importers are granted VAT exemption at importation (for example, mining sector, public investment project operators). This creates a risk of diversion. Customs needs to assess the diversion risk of VAT exemptions for targeting at post-clearance audit or end-use verification and incorporate that VAT diversion risk in close cooperation with the tax administration.
An import can be divided into several small shipments (declarations), evading customs control by making each of them lower than the threshold of normal customs procedures and/or VAT de minimis. This is already a problem in customs duty collection, but as VAT covers more commodities, the significance may be larger than customs duties alone. Customs should consider strengthening collaboration with the tax administration, intermediary service providers, and other stakeholders to create a solution (for example, better profiling of shippers and importers, intermediary collection model using vendors, buyers, consumers, and so on). The profiling of exporters and importers needs to be strengthened to trace similar transactions in the past.
VAT de minimis at the importation can be very low or there is no de minimis, regardless of the customs duty de minimis. This means that all the trade and passengers’ goods are subject to VAT on import. This includes in certain countries where local residents cross the border for grocery shopping. Customs needs to review the border processes so as not to create queues for processing VAT on low-value goods (and to advise policy makers of necessary mitigation, for example, change in the VAT de minimis at importation and consider negotiating a VAT cross-border adjustment mechanism with the neighboring countries17).
Export VAT refunds need customs support. The amount of the export VAT refund is the VAT paid during the production of the exports; thus, customs may not need to assess the exports’ value for this purpose but may need to verify that the goods have physically left the country to prevent export VAT fraud. Export verification that the goods exit the country has not been a customs’ interest for decades in many countries.18 Customs needs to reconsider its important compliance role in export monitoring.
Domestic goods’ shipment to a SEZ may be treated as an “export” and eligible for VAT refund under the VAT law, while it may not be an export under the customs law. This may create a pitfall, and neither revenue administration may monitor such movement. Similarly, in some countries, citizens buy items, such as groceries, in the SEZ to avoid VAT. Customs needs to strengthen in/out monitoring from the SEZ regardless of the goods’ status (international or domestic goods) and in cooperation with the tax administration.
An estimate of the compliance gap regarding VAT on imports is difficult as national accounts are based on declared value. Mirror analysis, comparing declared imports with declared exports by exporting countries, is a powerful tool to detect customs fraud when conducted at the finest possible level of detail. However, as there may be many potential explanations for data discrepancy, estimates of missing revenue due to fraud or customs malfunctions cannot be derived directly from the mirror analysis.19 More credible gap analysis uses surveys of direct observation of imports or shadow/informal economy studies, but they can be difficult and time-consuming, present incremental results, and be subject to systematic bias. Box 2.2 illustrates some methods applied to estimate the evasion of VAT and other taxes on imports. A compliance gap found in imports does not necessarily translate directly into the total VAT gap. If evaded, import VAT simply reduces input tax credits (that is, provides cash flow benefits only to evaders); it will not contribute directly to the total VAT gap. Nonetheless, any compliance gap found in imports is an important risk indicator for compliance, indicating likely systemic risks in downstream supply chains.
Methods Applied to Estimate the Tax Evasion on Imports
Several methods have been used to estimate the tax evasion of VAT and other taxes on imports. Overall, such models are categorized into two approaches: “bottom-up,” which is based on an analysis of a “microeconomic” nature, that is, disaggregated data from surveys, samplings, and audit, often in a specific trade sector and activity; and “top-down,” which is based on an analysis focused on macroeconomic data and national accounts. More generally, noncompliance in taxes on imports is included in estimates of the total compliance gaps for individual taxes, though it is not usually quantified as a specific component of the tax gap.
Bottom-Up Approach
Market Intelligence. Interviews with legitimate economic operators, who can be domestic producers or distributors, may provide information of irregular market trends and sometimes more information relevant to the contraband products as a whistleblower or competitor. A price comparison between the identical foreign goods sold in a domestic marketplace and declared value at the importation may provide hints of informal activities. As another market intelligence method, a study comparing the data of imports, final consumption in the domestic market, and exports of certain products may provide information to detect informal activities. In this method, it is important to target certain sensitive product group(s) and regularly examine both import and export statistics as well as consumption patterns in the domestic market.
Specialized Market Research and Garbology. There are companies that carry out special market research to estimate the size of informal markets through, for example, garbology, which is the study of trash and garbage. The result could indicate an actual size of foreign products in the market, which can be compared with customs clearance data or even, for some products, an indication of the amount of smuggled goods directly through checking manufacturers’ labeling of packaging.
Surveys of Wholesale or Outlet-Type Stores. This is especially relevant when the traceability framework is established by tax stamps, chemical markers, and traceability coding. The key requirements for this type of survey are a high level of point-of-sale coverage and a preferably quick and efficient method of determining whether products have been taxed.
Control on Passengers’ Belongings. This is relevant to portable excised items and, in certain countries, luxurious goods, which can be wearable and kept in a hand luggage, particularly when most smuggling is carried out by passengers who disembarked on foot or in small vehicles through a few border-crossing points. For certain contexts—for example, high excise duty on tobacco products—the incidence of this type of smuggling could be very high. Yet the control could be labor-intensive and sometimes physically difficult because of too many passengers, in which case, statistical sampling techniques could be used to make the exercise cost-effective.
Cross-Check between Customs Clearance Data and Tax Administration’s Tax Return Data. Trade transaction data can be compared with the tax return data, that is, in general income and/or VAT returns (sales reports and information on the VAT and the other taxes paid on imports). This can be a very useful method to detect tax evasion but depends on consumers’ reporting of the consumption or purchase of goods, which can take time. To improve cost-effectiveness, it is also important to target certain sensitive product group(s) either because the product group(s) represent a high risk or because the product group(s) are a good indicator of what is happening at the sector level.
Top-Down Approach
Mirror Analysis of Trade Statistics. National import statistics can be compared with trading partners’ export statistics and national export statistics can be compared with trading partners’ import statistics, both in terms of volumes and values by commodity or commodity group and by country. The gap between the two may provide indicative information that needs further examination on several aspects, one of which may be possible fraud.
Based on Estimated Black-Market Size. There can be several approaches to estimate black market size. An example is calculation of discrepancy between the income measures of GDP and the expenditure measures, which discrepancy may represent informal activities as the incomes side is measured through the value added by the formal economy while on the expenditure side includes self-reporting.20 Based on this estimated consumption including on the black market, import size including fraud may be estimated, which can be compared with the data based on the customs clearance data. This method relies on the quality of income and expenditure measures of GDP, and the discrepancy between the two can also be attributed to other factors, such as differences in sampling, whose impact cannot be separated from that of informal activities.
Despite the challenges listed previously, VAT collection at importation may still be less difficult than VAT collection in the domestic value chain where domestic economic activities are more difficult to capture for tax administrations. Comprehensiveness of VAT collection is often measured by C-efficiency, being defined as follows:
One hundred percent C-efficiency means that there is no missed collection. In reality, this never becomes 100 percent because there are various types of gap, broadly categorized into two groups: (1) a policy gap, namely the additional revenue that would be raised, given perfect enforcement, if all consumption were taxed at the current standard rate (for example, no exemption/zero-rating); and (2) a compliance gap, namely the additional revenue that could be raised if current VAT rules were perfectly enforced. Figure 2.1 indicates C-efficiency and the estimated decomposition of the gap across income groups.
C-Efficiency and Decomposition of Gap
(Left scale: VAT gap, % of GDP; right scale: gap C-efficiency × 100)
Source: Keen 2020.Note: VAT = value-added tax.C-Efficiency and Decomposition of Gap
(Left scale: VAT gap, % of GDP; right scale: gap C-efficiency × 100)
Source: Keen 2020.Note: VAT = value-added tax.C-Efficiency and Decomposition of Gap
(Left scale: VAT gap, % of GDP; right scale: gap C-efficiency × 100)
Source: Keen 2020.Note: VAT = value-added tax.In considering the nature of VAT, if C-efficiency is low and the compliance gap is large, undervaluation at importation may not be compensated subsequently in the value chain. Therefore, customs administrations must focus more on valuation.21
Customs administrations understand that a large percentage of VAT on import becomes an input tax credit for domestic businesses. Having customs administrations devote more attention to valuation control is not enough. The customs administration should help the tax administration improve the capture of the subsequent value chain by sharing import transaction data and risk profile information of taxpayers. This can be done through better customs–tax cooperation (details discussed in Chapters 3 and 7). To follow up this agenda, a data item of VAT on imports should be created in the tax revenue statistics and monitored.
Excises
Insofar as excises are levied on business inputs, they are not economically growth friendly. However, excises may be useful to reduce overall demand for targeted goods that are deemed harmful to society (because of their adverse impact on health and the environment, for example). In the modern world, excises are used as a tax on externalities. Thus, excises can discourage the consumption of harmful goods, including alcoholic beverages, tobacco products, and fuel, especially if they are taxed at specific rates, such as per kilogram or per unit—with the assumption that cheaper goods may be worse (for example, more polluted, more harmful, less energy efficient). Excises are charged at the time of ex-factory or importation. In those countries that do not produce such items, excises are collected solely on imports. As society matures, becoming more socially conscious, more interested in environmental stewardship, and advocating for more control over externalities, the need to apply excises continues (for example, on fuel, tobacco products, alcoholic and carbonated beverages, and petroleum products).
“Excise, as a tax on externalities, fits in the modern world; its management needs more technology, notably traceability.”
The internationally established practice on excisable items is to secure traceability22 through which customs post-entry control and the buyer can identify if the item is legitimate or smuggled. Traceability technologies and services have grown for several purposes, not only for customs administration but also for other public sector and private sector use, that is, supply chain management, logistics management, product recall capacity, and intellectual property rights (IPR) infringement controls. While excises are targeted at specific items, there is always the problem of gray zone products, including issues of goods classification. Since volume is often the tax base of several excises, measurement of volume remains an important issue in customs administration (for example, how to measure the liquid volume inside a metal tank).
Import Tariffs
Import tariffs are not advisable from the perspective of growth-friendliness because they distort decisions of both consumers and producers. However, they may be considered necessary to protect temporarily certain domestic “infant” industries and/or maintain certain levels of domestic production of essential goods (such as food or medical products). Although import tariffs remain an important source of tax revenue in many developing countries, particularly those with relatively low incomes or lacking the capacity to implement internal taxes, there is a clear need and, in fact, tendency to reduce tariff rates (whether multilaterally, unilaterally, or otherwise). (See more details in the section “Trade Policy.”) Table 2.1 indicates such a decline in import tariff rates, regardless of the level of development or region. It is noteworthy that VAT rates are higher than the simple averages of the applied most favored nation (MFN) tariff rates; tradeweighted average applied MFN tariff rates and applied preferential tariff rates are even smaller than the simple MFN averages.
Customs Import Tariff Rate and VAT Rate
Customs Import Tariff Rate and VAT Rate
| Group | Tariff rate | VAT rate | ||||
|---|---|---|---|---|---|---|
| 1990 | 1998 | 2008 | 2010 | 2018 | 2020 | |
| All countries | 11.2 | 9.8 | 8.0 | 8.3 | 6.9 | 16.1 |
| OECD countries | 6.2 | 5.2 | 3.0 | 3.2 | 2.7 | 19.4 |
| Non-OECD countries | 16.7 | 12.2 | 9.2 | 9.4 | 8.0 | 14.9 |
| African countries | 19.8 | 18.3 | 12.9 | 12.5 | 10.3 | 15.8 |
| Asia Pacific countries | 37.5 | 9.9 | 8.7 | 7.8 | 7.5 | 11.6 |
| Middle East countries | 28.1 | 25.1 | 8.9 | 8.8 | 6.8 | 13.0 |
| Western Hemisphere countries | 33.5 | 11.2 | 8.5 | 10.5 | 9.0 | 14.8 |
Customs Import Tariff Rate and VAT Rate
| Group | Tariff rate | VAT rate | ||||
|---|---|---|---|---|---|---|
| 1990 | 1998 | 2008 | 2010 | 2018 | 2020 | |
| All countries | 11.2 | 9.8 | 8.0 | 8.3 | 6.9 | 16.1 |
| OECD countries | 6.2 | 5.2 | 3.0 | 3.2 | 2.7 | 19.4 |
| Non-OECD countries | 16.7 | 12.2 | 9.2 | 9.4 | 8.0 | 14.9 |
| African countries | 19.8 | 18.3 | 12.9 | 12.5 | 10.3 | 15.8 |
| Asia Pacific countries | 37.5 | 9.9 | 8.7 | 7.8 | 7.5 | 11.6 |
| Middle East countries | 28.1 | 25.1 | 8.9 | 8.8 | 6.8 | 13.0 |
| Western Hemisphere countries | 33.5 | 11.2 | 8.5 | 10.5 | 9.0 | 14.8 |
Impacts of tariff reduction on revenue may be diverse depending on elasticities of demand for imports—to what extent trade volume will increase by reduction in the prices (duties)—which may differ by commodity and by country. The volume effect also impacts collection of VAT on imports, but it may be positive, as VAT generates revenue even from duty free imports.23 Trade facilitation reduces the goods’ price through reducing trade transaction costs without reducing the duty rates.24 With proper trade facilitation and no decrease in compliance, the anticipated effect of trade facilitation is an increase in both customs duties and VAT on imports. At least, when looking at the share of each tax in customs collection, the share of customs duties declines while the share of VAT on imports increases. The decline in the share of revenue from tariffs as a proportion of total tax revenues has been largely offset by increased revenues from VAT on imports. Today’s typical customs collection for a low-income country that has a VAT consists of VAT on imports (50 percent), excises on imports (25 percent), customs duties (15 percent), and miscellaneous (10 percent).25 The foregoing figures are indicative and differ country by country; for example, if a country’s trade is predominantly with RTA partners, the customs duties’ share in customs collection may be nearly zero.
Thanks to the VAT on imports, the customs administration will remain an important agency for domestic revenue mobilization even as trade taxes continue to decline.26 Also, excises will continue to play an important role in addressing externalities. The share of revenue collected by customs in total tax revenue— defined as duties and taxes collected using customs resources, notably VAT on imports, excises on imports, and customs duties—is approximately 50 percent in lower-income countries and 10 percent in higher-income countries (see Figure 2.2). It is noteworthy that, even in advanced countries, customs continues to be a meaningful revenue collection body. In some countries, the governments underestimate the customs revenue collection role and perceive that customs emphasizes only trade facilitation and border security; they should reconsider the customs role in revenue, particularly with revenue collection continuing to move up the important agenda of governments to finance measures necessary to address emerging needs, such as the COVID-19 crisis, and to achieve the Sustainable Development Goals.27
Customs Collection’s Share of Total Tax Revenue in Relation to GDP per Capita
Source: IMF staff calculations using WCO (2018b).Customs Collection’s Share of Total Tax Revenue in Relation to GDP per Capita
Source: IMF staff calculations using WCO (2018b).Customs Collection’s Share of Total Tax Revenue in Relation to GDP per Capita
Source: IMF staff calculations using WCO (2018b).Carbon Border Tax from the Customs’ Administrative Perspective
The carbon border tax (CBT), also known as the carbon border adjustment mechanism, has been discussed in the the European Union and the United States. The premise is that the tax would reflect the amount of carbon emissions attributed to goods imported into the country. It may give rise to rebates to exports. The revenue may be used for subsidies, including export subsidies, to domestic industry to compete with foreign producers with relaxed carbon emission regulations and to prevent the move of domestic production outside the country. CBT’s purpose may be to create a level playing field, which appears closer to the purpose of excise duties on imports with possible rate differentiation by goods’ origin.
“As the carbon border tax is being designed, it is imperative that customs provide input on enablers and challenges from the perspective of implementation.”
CBT is a new tax, likely to be collected by customs administrations. It is still under design by some countries, and many details are not yet known, including if this will be akin to customs duty or excise. The European Union’s program was announced in June 2021. This chapter does not discuss CBT’s tax policy aspects—for example, alignment with the WTO rules, the level of tax rate by commodities, how to set the rate, and the impact to the economy and particular industries—but discusses possible issues from the perspective of administration.
CBT may increase customs revenue collection significantly.28 Therefore, during the design stage, thorough preparation by customs is imperative, which includes input to the policy makers on administrative enablers and challenges from the perspective of customs administration. If CBT becomes a tax that is difficult to administer and enforce by customs, a satisfactory level of compliance will not be achievable, and CBT will likely fail to meet its original objectives. Some of the possible challenges in CBT implementation are described in the following paragraphs.
Procedures and Selectivity Criteria. CBT will have multiple rates by commodity and on the same commodity coming from different countries, which apply different carbon prices. The commodities subject to CBT may not be clear—for example, imports of commodities under the steel, cement, paper, and other specified sectors. The tax rates may be determined by carbon pricing or an index calculated by the carbon footprint matrix, which may provide different rates by industrial sector (or commodity) and by country (for example, exporting, manufacturing). In addition, producers in countries (hopefully not particular companies in the country) with carbon-pricing mechanisms that the importing country agrees are compatible with its own may be exempt from this tax. This may look like a rule-based discriminatory tariff. Development of the tariff schedule in the customs clearance ICT system may be labor-intensive but not difficult. Yet, because CBT will discriminate imports by commodity and country, based on the rules of origin (RoO)-related challenges being faced by customs administrations in RTA implementation, the actual procedures and administration may be complicated, and the administrative burden may need to be reassessed. Also, there will be a risk of classification slippage and forged country of origin. Customs administrations should assess the possible risks of fraud and prepare to modify the selectivity criteria accordingly.
Determination of Goods Origin. In most cases, for imports applying RTA preferential duty treatment, the certificate of origin must be presented to the customs administration. Since CBT covers all the countries, it may need proof of the goods’ origin for all the imports (or those commodities subject to CBT). A question remains if CBT will: retain third-party certificates of origin, replace them with self-certificates by the manufacturer or exporters, or will not ensure the goods’ origin. It is likely that re-exported products with/without manipulation and secondhand products will face confusion because their linkage with the goods’ origin is weak. Traditional third-party certificates will be so labor intensive and costly that it would disrupt the supply chain (Hillman 2013). The complexity of rules of origin and certificate of origin as well as self-certification of goods’ origin is explained in the following section of this chapter. Customs may lack the capacity to verify the origin of all the imported goods without help from foreign partners and disruptive technologies (Chapter 7).
Traceability. A carbon footprint matrix may be produced by commodity and by country. Intermediary material can be shipped to the other country where a product is produced using this material. For example, Japan can produce a car using Japanese steel, but it can also use a Chinese steel product. If the company is conscious of a risk of supply chain disruption, it is reasonable to divert the material/parts and even manufacturing lines. A manufacturing company may not know the origin of the material and parts it is using, and that probably is ever changing. In addition, since CBT may be discriminatory taxation from the point of view of the manufacturing country, legal or illegal circumvention will be inevitable.
From the customs administration perspective, a question would be how the cross-border supply chain will be accounted for or not accounted for in CBT and whether customs needs to verify it. Some customs administrations may be, to some extent, knowledgeable in traceability and the value chain in production through experience with the value-addition rule of origin in RTA (for example, cumulative criteria of RoO). Traceability of materials/parts will represent an enormous workload, and even when customs finds irregularities in the documents, it is not clear what sort of corrective measures are possible when the document is forged by an exporter (for example, a penalty to the importer?). But importers may be a victim too (unless there is collusion with the exporter/manufacturer). Although it depends on the rules of origin, information on origin of intermediary material may be overwritten by the final product. Statistics of trade in value added (TiVA) is a delayed index, an academic product, and not yet a base for taxation purposes.
Cooperation with Stakeholders. CBT may give rise to an export rebate. Such a rebate would be equivalent to a VAT refund or excise refund for export or to inward processing linked to inputs and a preset yield (see “Investment Policy (Duty/Tax Incentives”) or could be more like an export subsidy linked to export value. Interagency cooperation with the tax administration, other line ministries, and economic operators will be needed. In considering the usefulness of international cooperation in verifying the self-declaration of origin issued by exporters and conducting other administrative assistance, international cooperation with foreign customs or other agencies might be also helpful to implement CBT.
Customs–Tax Cooperation
Other chapters, particularly Chapter 3, discuss customs–tax cooperation in more detail. Tax administrations all over the world struggle with strengthening their capacity to capture and trace the value chain. Importation is a significant starting point in the value chain in the country, and the customs administration basically captures the entire importation. Customs’ trade transaction data help tax authorities trace the value chains, starting from the imports, and assess the corporate income derived from exports (and expenditure on imports). Tax administration information (for example, sales reports) is useful for customs to conduct postclearance audits. For both administrations, sharing risk profiles of traders and taxpayers helps them improve their risk management and targeting for audit and control.
Customs also functions as a tax withholding agency for certain domestic taxes. VAT payments on imports are business input credits for subsequent domestic economic activities after the importation.29 There are countries where customs administrations collect a certain amount of advance corporate income tax at the time of importation to combat tax evasion. (This advance tax can then be credited against eventual corporate tax paid if the enterprise is in a taxpaying position.) For these practices, a good working relationship and cooperation between the two administrations are imperative to success.
Customs’ role is increasingly important in combating the evolving base erosion and profit shifting used by multinational enterprises (MNEs) to shift their profits to lower tax jurisdictions and thereby avoid income taxes.30 Customs data can play a useful role in enabling tax administrations to detect under-and over-invoicing. Customs’ ICT clearance systems apply to all imports and exports, and its selectivity system can easily report unusual unit values of imports and exports. Regardless of the customs duty rate and duty exemption, customs should monitor the value of both imported and exported goods as this can help detect possible abusive transfer pricing practices. The same can apply to trade-based money laundering and the data sharing with the financial intelligence unit. Domestic transfer pricing can also happen if the national laws grant companies operating in a SEZ lower statutory corporate tax rates than outside the zone and do not prohibit an establishment of a subsidiary in the SEZ. Although this is not recommended practice, if it occurs, as the tax administration may not have access to economic activities within the SEZ, customs should share the pertinent data with the tax administration and help it address domestic profit shifting.
Trade Policy
Multilateral Trading System
Trade policy today is regulated by the WTO rules, namely the multilateral trading system. Welfare gain through trade liberalization, particularly for small countries, is apparently widely understood, and to a very large extent countries follow the multilateral trading system. Box 2.3 outlines the principles of tariffs in the multilateral trading system.
Tariffs and Multilateral Trading System
Tariffs are the only permissible instrument of trade policies.31 Domestic tax, user fee, quantitative restrictions, technical requirements, subsidies, exchange rate policy, and other instruments must not be used for trade policy unless such exception is provided in the WTO rules.
Maximum tariff rates of each WTO member are committed to the WTO. Each WTO member submits a schedule of concessions, including a list of bound rates by goods’ classification, beyond which ceilings it cannot increase the duty rates without compensation to the trading partners.
Tariffs are subject to most favored nation (MFN) treatment. MFN stipulates no discrimination between trading partners’ goods: that is, concessions accorded to one country’s goods should be granted to those of all countries except cases of RTAs and Generalized System of Preferences (GSP).32
The applied duty rates are often lower than the bound rates. This is because bound rates are the maximum rates within which WTO members can set the duty rates (applied rates) freely subject to MFN, preferential duty rates may be applied under RTAs, and developing countries are allowed not to bind substantial scope of tariff lines.33
Domestic tax and user fees are also regulated by the WTO, particularly national treatment (NT). NT requires that imported goods be treated the same as or no less favorably than “like” or “directly competitive or substitutable” goods produced domestically so as to ensure that discriminatory internal taxes (as well as other regulations) are not used as substitutes for tariffs.
WTO members should reduce trade restrictiveness of any measures as much as possible, including nontariff measures (NTMs). NTM has similar trade restrictiveness to tariffs (or could be worse due to sunk cost). Its trade restrictiveness can be calculated by the cost to the trade, known as tariff equivalent. Trade facilitation is regarded as an instrument to reduce the tariff equivalents of customs and trade procedures.
WTO member accession needs compliance with WTO rules and conclusion of bilateral market access negotiations with interested WTO members. For example, a least developed country seeking a membership to the WTO can expect other WTO members to request it to bind all of their agricultural tariff lines at an average rate of 50 percent and 95 percent of their nonagricultural tariff lines at an average rate of 35 percent (WTO 2012).
Following the successful conclusion of the Uruguay Round of trade negotiations and the establishment of the WTO in 1995, the simple average applied MFN tariff rate fell from roughly 18 percent to almost 10 percent in 2008, whether in line with WTO members’ multilateral commitments or due to their unilateral action. This reduction in tariffs is in recognition of their distorting nature and the benefits of trade liberalization. As a consequence of the breakdown in the multilateral Doha round of negotiations in July 2008, the simple average applied MFN tariff has declined, but much more slowly since then, to approximately 8 percent in 2018 (WTO 2021). While developing and least developed countries’ average applied MFN tariff rates have also continued to decline gradually since 2008, to 8.4 percent and 11.7 percent, respectively, they remain much higher than the average of developed countries (4.3 percent). Interestingly, more than half of the reduction in applied MFN tariffs since 1995 was unilateral. Considerable unilateral cuts were also made by developing countries, notably Bangladesh, India, Kenya, Morocco, Nigeria, Peru, and Tunisia (World Bank 2020).
“Countries reduce the tariff rates through market access negotiations with foreign countries as well as unilaterally.”
Regional Trade Agreements
As discussed in Chapter 1, the number of RTAs has increased significantly, and there are many overlapping agreements with significant implications for customs administration. The overall impact of this trend is contributing to the decline in tariff revenues. Also, it increases the needs for monitoring and control of the implementation of RTAs, which requires customs to distinguish between MFN imports and imports from RTA partners in order to levy the appropriate tariff for the former and grant preferential treatment to the latter.
The implementation of RTAs requires ensuring adherence to the RoO, which is complicated and different in each RTA.34 RoO are composed of three elements: origin criteria; consignment criteria (for example, trading route, nonmanipulation requirements); and procedural provisions (for example, certificate of origin, certificate of nonmanipulation). Origin criteria may be different by tariff lines and by RTA. Origin criteria may be whether the products are wholly obtained in the country of export. It may depend on to what extent the products are obtained in the country incorporating materials which may or may not have been wholly obtained there, or whether the materials have undergone sufficient working or processing, and so on.35 These challenges become more acute when a country is a signatory to several RTAs, as preferential rules of origin for the same goods may differ from one agreement to another. In addition, the introduction of free trade between subgroups of countries makes it necessary to effectively control imports from third countries, which imposes a heavy burden on customs. Under these conditions, anecdotal examples indicate that the quality of the customs of each member country depends to a large extent on the quality of the weakest link among these countries.36
Some origin criteria require tracing back the process, for example, the value addition in producing the imported goods or the location obtaining substantive parts and processing. In practice, customs administrations do not have such ability and may rely on the third-party certificate of preferential origin (C/O) issued or endorsed by the authority of the exporting country, which is usually the obligatory document in applying RTA preferential duty rate in the importing country. Depending upon the RTA, C/O may be delivered by the customs administration or other specified issuing agency of the exporting country (for example, chamber of commerce) having its authenticity and regularity confirmed by the customs administration.
The future trend is replacement of third-party C/O with self-declaration of origin by manufacturers, exporters, or importers,37 making importing countries’ customs administrations more vulnerable to the risk of error and forged origin information than third-party C/O. In addition, verification of authenticity and its contents entail sovereignty challenges because the parties issuing selfdeclaration are located in foreign countries and the importing country’s customs administration does not have access to all necessary information and the authority to control these foreign entities. Therefore, these RTAs stipulating self-declaration have provisions for international cooperation between customs administrations, among which are best efforts clauses. New technologies, such as blockchain, may ensure the authenticity of the self-declaration, but they do not guarantee that the contents are accurate, and verification of accuracy requires international cooperation with foreign authorities (also see in Chapter 7).
“Growing RTAs create challenges for customs through complex rules of origin and by self-declaration of origin.”
For many customs administrations, this RoO function in export is a new role. This also applies to their responsibility to advise companies established in the country of any changes they may have to make in their supply chains and manufacturing processes if they wish their production to comply with the RoO laid down by the RTA and to be eligible for preferential tariffs on imports in partner countries.
Investment Policy (Duty/Tax Incentives)
Customs Administration and Inward Processing
In order to promote export-led growth and, according to the government’s investment promotion agencies, generate associated relatively well-paid employment, among other things, many governments of both developed and developing countries are keen to attract foreign direct investment (FDI). FDI acts as a catalyst for these countries’ integration into GVCs by providing not only foreign capital but also technical, managerial, and marketing know-how. Traditionally, customs laws provide for duty relief in connection with such investment, notably that for inward processing, by exempting from import tariffs those imported raw materials and intermediate inputs that are used in the manufacture of exports, thereby facilitating economic activities.
Of course, the import duty exemption is conditional upon the export of the products in which the imported inputs are embodied. If the export condition is not met, the import duty is to be paid. If the duty-exempted goods are circulated in the domestic market without paying duty, this constitutes customs fraud— namely, misuse or diversion. To prevent and suppress such risk, customs administration monitors the import of raw materials and intermediate inputs, together with the export, as well as the associated inventory under this regime. Such monitoring involves an assessment of the “yield” (that is, how much raw materials/intermediate inputs are used to produce a certain quantity of exports), which has been agreed between the customs administration and the applicant, often in consultation with an expert, the line ministry, an investment board, and so on. Customs monitoring and control on inward processing are based on quantity and not on value.
In some countries, manufacturers’ inward processing inventory data can be electronically reported to the customs administration and compiled automatically, and in the case of exportation, the system automatically applies the “yield” and adjusts the record accordingly. Hence, monitoring is automated. Control of exempted goods is through desk audit and end-use verification at the site. Targets for control should be carefully selected, applying risk management (as explained in Chapter 5). Some countries also exempt capital goods, such as machinery and equipment used to manufacture exports and, in a few cases, motor vehicles for the use of employees. For these capital goods, an inventory is agreed with the customs administration, and monitoring (or annual status declaration by the applicant) and control are exercised by customs. Exemption of such capital goods may be replaced with extendable import suspension.
Special Economic Zones
A recent phenomenon in investment promotion is the increased use of tax preferences in addition to relief from customs duties. Tax preferences, which are among the most prominent features of SEZs, include exemptions from other indirect taxes (especially excises and VAT) and relief, if not exemption, from direct taxes (corporate and personal income taxes and social welfare charges).38 In addition, nontax incentives include loans with low interest rates, flexible conditions to establish a company and regulation with regard to corporate management board composition, relaxed regulations concerning remittances (including dividends), simplified corporate reporting, flexible labor standards, and so on. Consequently, in several developing countries, tax/duty preferences are no longer stipulated in customs law or tax laws but are provided for in other laws (for example, Investment Promotion Law, Special Economic Zone Law).
Different countries define SEZs differently. SEZs can cover free zones (FZs): an FZ could be an independent customs territory, that is, a foreign territory under the customs law and possibly in other laws too. FZ can set different tariff schedules or become a duty/tax free zone. An FZ often has its own administrative structure, including its own customs and customs laws. SEZs in developing countries may contain partially or entirely the features of an FZ.39 Since one-stop border posts (OSBPs) became popular at land borders—where two countries’ border authorities sit side by side in the same building—SEZs centered in OSBPs, for example, cross-border economic zones (CBEZs), might emerge.40 SEZs are so attractive to policy makers that, as seen in Chapter 1, the number of SEZs continues to increase. Nevertheless, there are failures where SEZs could not attract investors or economic activities and job creation did not meet expectations.41
Besides SEZs, massive infrastructure projects, such as dam construction, highspeed railway construction, and so on, are often granted tax/duty exemption for certain imports for construction and its operation. Again, they are not stipulated in customs law but in special laws or presidential decrees superseding customs law. They may not be treated as a SEZ, but the features and challenges to customs administration are almost identical.
The following paragraphs explain challenges associated with SEZs for customs administration.42
Organizational Challenges. To manage SEZs, some countries create a special government agency (instead of customs administration and tax administration), such as an investment promotion board, an organization equipped with staff and ICT systems. SEZ operators and SEZ users must then deal exclusively with such an organization and not the customs administration. In certain countries, customs administration (and tax administration) may have neither any authority over nor access to the SEZs.
Resource Challenges. In the past, the customs administration granted permission to operate inward processing under the customs law, including, for example, sustainability of business model, location (accessibility of customs officer), physical facility (wall, enclosure), and management responsibility. This permission may have been postponed, rejected, or modified in considering the availability of the necessary customs control staff.43 Under SEZs, customs administration may not even be consulted by the responsible government agency (for example, line ministry or investment promotion agency), which may not impose a requirement to fence the entire facility. Scarce customs resources will undoubtedly become increasingly stretched due to the proliferation of SEZs. End-use verification may be similar to post-clearance audit, but the purpose of the visit and focus are different.
Accountability Challenge. Government agencies promoting investment will ever increase the number of SEZs and the SEZ users (firms operating in/under the SEZ). In many countries, the fiscal impact of SEZs and its growth are not properly assessed in the budget bill, and the associated tax revenue forgone is often ignored. It is often observed that a customs administration does not meet its revenue target because of the significant size and growth of tax revenue forgone. Forgone revenue could equal the amount actually collected by customs. Important questions to consider are whether the investment promotion agency estimates the increase in the number of SEZ and SEZ users; whether it (or the Ministry of Finance) estimates the size of forgone revenue; whether the Ministry of Finance (and customs and tax administrations) is consulted in the SEZ application process (new SEZ, new users operating in/under SEZ); and whether they can postpone/reject/impose conditions in granting approval. Monitoring and evaluation of reliable data on the tax revenues forgone because of tax preferences are the foundation for evidence-based policy making and public accountability.
Operational Challenges. Conditional tax/duty exemptions always run the risk of diversion of goods into the domestic market without payment of duty/tax. The key to success is that the customs administration (and the tax administration) has authority to exercise as much control over goods imported into SEZs as it does over ordinary imports. Formidable challenges arise if customs does not have such authority or does have the authority but needs prior consent of the other government agencies (for example, investment promotion board) in order to conduct a control in each case.
In addition, unlike traditional customs inward processing, certain countries grant relief from much broader direct taxes, such as corporate income tax. If the corporate tax rate is lower in the SEZ than in the rest of the country, abusive/aggressive transfer pricing can happen within a country, enabling a corporate entity operating inside and outside the SEZ to shift profits into the SEZ from elsewhere in the domestic economy, thereby evading taxes. As customs usually controls the border between the SEZ and the rest of the country, the customs administration can and should help the tax administration to detect abusive/aggressive transfer pricing44 through, for example, exchanging transaction data and high-risk profiles and exploring possible joint audits in SEZs. Even in cases where the duty rate is zero, customs valuation and value monitoring/control remain important to monitor intra-corporate trade activities and combat possible abusive/aggressive transfer pricing. The latter can be avoided, if, as advised by the IMF, tax relief in SEZs is confined to tariffs and other internal indirect taxes (or, as in some countries, related corporations cannot operate inside and outside the zone).
“SEZs, getting relief and exemption from customs duties and other taxes, need thorough monitoring and control, and there should be strengthened cooperation with tax administrations.”
Trade statistics on goods in and through SEZs are not clearly harmonized across countries. The customs administration should be aware that certain SEZs, particularly those established in a transshipment port, may be used to camouflage the origin of the goods imported and re-exported with little, if any, addition of value or substantial process in order to avoid tariffs or other measures.45 Customs-to-customs international cooperation may exist, but if the customs administration of the SEZ country does not have access and a mandate to manage the data on activities in the SEZs, the customs administration of the importing country needs to explore how to ensure the traceability of goods, for example, nonmanipulated certificate issued by the SEZ authority (for the purpose of rules of origin, RTA consignment criteria,46 and so on).
Finally, there are also nonfiscal risks, such as money laundering, illicit drug smuggling, organized crime, terrorism, and intellectual property rights violations. While these matters are beyond the scope of this book, they also highlight the importance of customs’ proactive authority and control of SEZs and activities therein.
Customs Valuation
Customs Valuation Rules
Before 1995, a customs administration could impose its determined value on the imported goods. The Brussels Definition of Value (BVD) stipulated that a normal market price is defined as “the price that a good would fetch in an open market between a buyer and seller independent of each other” and countries compiled paper books of market price of each product. The system was more like an “imposition system” than a “declaration system.”47 Under this system, a list of market prices for each product (by product, not commodity, and so much more detailed than the tariff line) was ultimately important. Many countries that adopted BVD compiled such data in paper folders, and in the 1990s an ICT database was developed called a minimum price database. Some companies were selling market price data sets or services to customs administrations to check the market price in the exporting countries, namely pre-shipment inspection for valuation purposes.
Today’s customs valuation rules, in contrast, are stipulated by the WTO Customs Valuation Agreement (VAL),48 which entered into force in 1995, and now all WTO members are obliged to follow it. The VAL stipulates that customs valuation must be based on the actual price of the goods to be valued, except in specified circumstances, which is generally shown on the international sales invoice—thus, it is a “declaration system.” This price, plus adjustments for certain elements that are also listed in VAL, equals the transaction value, which constitutes the most important basis for valuation. When there is no transaction value for the imported goods or when the declared transaction value is not acceptable as the customs value because the price has been distorted as a result of certain conditions, the VAL enumerates five other valuation methods (so there are now six methods) to be applied in the prescribed hierarchical order (WTO [1994]): (1) transaction value, (2) transaction value of identical goods, (3) transaction value of similar goods, (4) deductive method, (5) computed method, and (6) fallback method. Most of the national customs laws have equivalent provisions, largely duplicating key VAL provisions.
Customs Valuation Controls
As market price is no longer the basis of value, customs administrations must not apply minimum prices to the customs valuation. The minimum price database was heavily criticized by some traders and academics because it lacks accountability, is not updated, ignores technological and business model evolution, is a nontariff barrier, and, most importantly, violates the WTO rules and is possibly subject to the WTO dispute settlement (and possible retaliation). Although VAL has been in force since 1995, customs administrations in developing and developed countries have faced problems administering this system.49 VAL has imposed a huge burden on customs regarding how to justify its doubt as to the truth or accuracy of the declared value. This includes the need to check the trade sales invoice’s authenticity, contents, and consistency with the declaration; to assess the relationship between the seller and the buyer; and to assess the adjustments, such as lease, royalty, commission, and consultant fee, which need a profound knowledge of international trade sales contracts. Some efforts by customs administrations to cope with VAL and to support practices for customs valuation are described in the following paragraphs.
Risk Management for Valuation Purpose. This is quite similar to the minimum price database, but the customs value reference database can help customs administrations filter a combination of information—that is, detailed goods description (tariff classification code), reference unit value, and exporting country or goods origin—in the selectivity module in the customs clearance system. (Details are presented in Chapter 5.) By this selectivity, if the declared unit value is lower than the reference unit value (by a certain percentage), the declaration may be selected for documentary check, and the customs administration may ask supplementary questions or ask for supporting documents to assess which valuation method should be applied. Commodities should be limited to those of high interest/high risk, and the reference unit value should be regularly updated, preferably with values validated by the customs administration in actual operations. Some companies are selling market price data sets for this purpose. Another frequently observed practice is that the customs administration analyzes its offense database to profile risky goods or trading patterns for lower invoicing and the results are reflected in updated selectivity criteria. This can be supplemented by trade data mirror analysis which may provide indicative risk information.
Postclearance Audit. Postclearance audit (PCA) has two objectives for valuation control: (1) to determine whether the selectivity criteria functions well (namely, compliance measurement) and (2) to detect valuation irregularities. Often random checking of the importation cleared through the green channel is applied to (1), while targeting based on risk management is applied to (2). Proficient knowledge of corporate books and accounting records, inventory records, and ICT software are needed for an effective PCA approach. PCA is also discussed in Chapters 4, 5, and 6.
Compliance Management. Traders’ compliance should be compiled and analyzed along with the information of sellers. Highly compliant traders face less or little control (for example, random check described previously) so that voluntary improvement in compliance can be motivated. Lowly compliant traders face more severe controls, thereby making their transactions more costly to their business partners than highly compliant traders. Thus, the market mechanism may also promote highly compliant traders. Some countries allow highly compliant traders to use a special sign (that can be used on business cards, webpages, commercial ads, and so on) to distinguish them from the others in the market. A similar concept is applied to highly compliant transporters or means of transport carrying only highly compliant traders’ goods (for example, dedicated lanes at the land border posts). Repeated fraud should result in increasingly severe penalties. Also, for this reason, compliance records should be well maintained. In many cases, traders are not compliant because the deterrent is not sufficient. There has been anecdotal evidence that customs officers may promote noncompliance to sustain their detection and thus penalty income; this malpractice should be eliminated. Chapter 6 addresses customs compliance programs in more detail.
Customs-to-Customs Cooperation. Valuation is the assessment of the international trade sales contract between the foreign seller and the buyer (not between the exporter and the importer; see Box 2.1). Accordingly, the foreign seller’s information (including if the seller exists, if the seller engages in this trade transaction, the sales price [value], and the seller’s compliance) is very helpful. Some countries may have legal constraints on the exchange of export value information, while others may not. Certain countries may have difficulty in push-type data exchange (where a whole data set is transferred), but pull-type data exchange (specified information with certain justification) may be less onerous.50 In many cases, bilateral/regional customs mutual assistance agreement (CMAA) 51 are helpful for such data exchanges. Anecdotal evidence indicates that such data exchange does not need to occur in real time, but even a quarterly exchange by batch file is sufficiently useful (in case of push type).
Customs–Bank Cooperation. International trade sales contracts can be seen as third-party information. If the international trade sales contract is using an LC, the commercial bank’s information, together with the transporter’s B/L and shipping documents, is useful supporting evidence. A few countries have direct contracts with commercial banks to obtain the B/L information containing the sales value and payment information.
Summary
Customs revenue performance is determined by the trend of imports, among other factors. Following the financial crisis in 2008, the average annual growth of world trade has been generally slower than that of GDP. Trade liberalization and slower growth in international trade have obvious implications for tariff revenues collected by customs administrations. This downward impact on tariff revenues can be offset or mitigated to the extent that reduced tariffs (trade liberalization) and reduced trade transaction costs (trade facilitation) stimulate imports, which in turn increases customs collection, including excises and VAT on imports. Therefore, customs administrations should continue to explore measures facilitating imports while not compromising the level of compliance.
The environment surrounding customs and policies impacting customs are evolving. RTAs and SEZs are not only liberalizing trade but also making trade more complicated and increasing fraud risks. Increasing intra-firm trade, trade between related parties, small/expedited shipments, and trade in secondhand items and goods-and-intangible mixed all complicate customs valuation and the collection of duty/taxes. The composition of customs collection will lower customs duties and increase excise and VAT on imports, which may have implications for compliance risk assessment and customs resource allocation. When the environment evolves, customs administrations need to do the same.
References
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Acosta-Ormaechea, Santiago, Sergio Sola, and Jiae Yoo. 2018. “Tax Composition and Growth: A Broad Cross-Country Perspective.” German Economic Review 20 (4): e70-e106.
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This subsection focuses on maritime cargo rather than cargoes transported by airplanes, railways, or roads.
The same situation also applies to the transportation between the regional hub and the final destination.
For example, Busan (South Korea), Colombo (Sri Lanka), Djibouti, Dubai (United Arab Emirates), Durban (South Africa), Hong Kong, Lomé (Togo), Long Beach (United States) Panama, Rotterdam (The Netherlands), Shanghai (China), Tanger (Morocco), Tema (Ghana), and Singapore.
See, for example, WTO (2019a). Also, OECD (2013) indicates that among OECD countries, GVCs are such that more than half of trade involves intermediate inputs.
See “Trade Policy Implications of Global Value Chains,” February 2020: https://www.oecd.org/trade/topics/global-value-chains-and-trade/.
AEO is preferential treatment for highly compliant economic operators. It is discussed in detail in Chapter 4.
For example, WCO (2018a) indicates the intermediary collection model where the intermediary service operator (for example, e-commerce provider, express-shipment company) calculates, collects, and remits all applicable taxes on behalf of the nonresident vendors, assuming these intermediaries have the knowledge to calculate and remit the accurate amount of taxes in the importation country. For projects started in Australia, New Zealand, the United Kingdom, and so on, the WCO also suggests other options, such as the “buyer/consumer collection model,” the “vendor collection model,” or a combination of the two.
Countries, such as Sri Lanka, tend to grant a generous waiver for the expatriate’s (temporary) return to the country, allowing them to bring substantive amount of imports without duties.
For example, the European Union removes the exemption for imports of goods in small consignments of negligible value (EU 2017).
RTAs are mainly addressed under GATT Article XXIV (free trade agreement and customs union).
The subscription business model is defined as a business model in which a buyer pays a recurring price at regular intervals for use of or access to a product.
In Hong Kong, for example, imports of “manufacturing services” reportedly amounted to HK$139.5 billion in 2011 or 3.4 percent of the economy’s total imports of goods and services (24.1 percent of total imports of services) (Census and Statistics Department, Hong Kong Special Administrative Region 2013).
Gemmell et al. (2014) show that consumption taxation is less harmful for growth than either personal or corporate taxation. It is also confirmed by Acosta-Ormaechea et al. (2018).
It also discusses withholding taxes on imports and/or exports, which partially or completely cover income tax obligations for informal traders.
This could be a very long-term perspective. One could argue that decline would be less pronounced in lower-income countries, whose economies continue to rely heavily on agriculture and manufacturing.
Acosta-Ormaechea and Morozumi (2019), for example, advocate that increasing VAT revenue through base broadening with fewer reduced rates and exemptions is more growth friendly than doing so through standard rate increases.
For example, Lesotho customs (Revenue Authority) collects grocery stores’ receipts at the border from the passengers who buy groceries in South Africa and bring their goods into Lesotho. Then it claims the amount from South Africa Revenue Authority to transfer to Lesotho.
Except those having an export tax. Also, transited countries are always keen that transit cargoes exit the country (but not as export though).
Import statistics are compiled by the country of the goods’ origin, while export statistics are compiled by known destination country. The two do not match due to transshipment, re-export, secondhand items in the third country, and so on. For example, a car manufactured in Japan was used in Thailand for a year and is re-exported to Cambodia: Japanese export statistics count zero to Cambodia, Thai export statistics counts one car export to Cambodia, and Cambodia import statistics counts one car import from Japan. Similarly, Singapore exports a massive volume of whisky to Japan, while Japan does not import from Singapore as no whisky is originated in Singapore.
This approach needs input from the statistics agency producing the national accounts figures being used. Published, balanced national accounts should include the nonobserved (informal) economy in all three aggregate measures of GDP, often as adjustments made to one measure or another in the balancing process. Such adjustments will need to be taken into account in comparing expenditure and income GDP figures.
If import VAT’s share is small in total customs collection and customs duties’ share is large, customs valuation is important. This does not necessarily mean that with high C-efficiency and a small compliance gap, customs administrations may lose control of valuation (because it will be recaptured in subsequent value chain).
Traditionally, a tax stamp seal. In modern days, unique tracking identifier.
Certainly, exclude few items of VAT exemption and zero-rated. Customs duty rate reduction will impact to VAT on imports with limited significance.
For example, since OECD (2002), trade transaction cost is estimated around between 2 to 15 percent of imports.
Similar composition is reported, for example, Kokoli et al. (2021). VAT collection on imports as percentage of total revenue collected by customs administration is found in Chapter 1’s Box 1.1.
VAT on imports may be refunded before final consumption, but in a sense, this is a withholding tax collected by using customs’ resources without which much of it may not be collected. VAT on imports should be assessed as customs collection.
A minimum tax-to-GDP ratio (or tipping point) of about 12¾ percent of GDP is associated with a significant acceleration in the process of growth and development. A country just above this threshold will have GDP per capita 7.5 percent larger after 10 years (Gaspar et al. 2016).
According to Pomerleau (2021), the European Commission estimated that the CBT could increase revenue in between EUR 5 and 14 billion (approximately 0.03 and 0.1 percent of GDP) annually to the European Union depending on the actual mechanism’s scope and design of CBT whereas current customs duties collection is EUR 26.7 billion, among which EUR 21.3 billion is of the European Union’s, that is, 13 percent of EU revenue.
At the outset of the introduction of VAT in a few countries (for example, in sub-Saharan Africa) where domestic tax administration is not ready to collect VAT and taxpayers are not ready to report VAT, the customs administration collects VAT on imports based on goods’ inflated customs value (for example, 110 percent, assuming domestic value addition as 10 percent).
For example, Hollingshead (2010) estimated that the estimated range for tax revenue loss due to trade mispricing in developing countries per year is between $98 billion and $106 billion annually during the years 2002 through 2006.
Except contingency measures, trade remedies, and export taxes and restrictions.
GSP is preferential market access unilaterally granted from advanced countries to developing countries, acknowledged by the WTO by its predecessor’s (GATT’s) decision, known as the “Enabling Clause.”
Bangladesh, for example, binds only 19 percent of its tariff lines. For those that are bound, the overall gap between the simple average applied MFN rate and the simple average bound MFN rate is 147 percentage points. Although this gap, coupled with the low binding coverage, provides Bangladesh with ample scope to raise applied MFN tariffs, its average applied MFN rate has nevertheless remained virtually unchanged during the past 10 years (WTO 2019b).
A study of 149 countries estimated that RoO reduced the trade creation effects of RTAs by around two-thirds of what it could have realized and that the costs of meeting RoO are equivalent to almost half of the available tariff preferences (Anson et al. 2005). Together with inadequate understanding of benefits of and requirements for traders, anecdotal evidence indicates that RTAs’ preferential duty rates are not fully used.
In an RTA for the European Union, for example, solvents are considered as originating if the value of all the nonoriginating materials used in their manufacture does not exceed 50 percent of their ex-factory price; by contrast, for calculating machines, the value of the nonoriginating materials used in their manufacture must not exceed 40 percent of their ex-factory price.
EU candidate countries, for example, are scrutinized for the adequacy of customs external border controls because they will be the external border of the European Union.
For example, the Japan-Australia Economic Partnership Agreement, the Association of Southeast Asian Nations (ASEAN) Trade in Goods Agreement, and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership.
Direct tax reduction/exemption linked to export is regarded as a prohibited export subsidy and subject to counter measures, according to the WTO rules (applied to all the WTO members). Indirect taxes preference is only within the zone; thus, when the goods exit the SEZ, indirect taxes gap, including customs duties, shall be paid.
For example, until 2020, Jordan SEZ had its own customs administration (staff were rented from Jordan customs) and own tax administration under its own laws.
For example, at a border zone between China and Mongolia.
Approximately 70 percent of SEZs in China were regarded as unsuccessful (Asian Development Bank 2018). Some SEZs in India, Kazakhstan, and the Kyrgyz Republic are also assessed as failure, yet there are no universally established criteria to assess success and failure of SEZs.
Also see WCO (2020).
In some countries, companies pay for any additional cost to customs administration for service.
Provided that the country has a legal framework regulating profit shifting and transfer pricing.
This has been a persistent practice since the introduction of the GSP as well as bilateral trade tension (bilateral trade imbalance disputes) since the 1970s. In order to be granted preferential market access of GSP or RTA or to circumvent the protective quota or punitive duties, companies attempted to change the goods’ origin by adding some value or processes, mostly not substantive processing, such as cleaning, labeling, packaging, or dying in transshipped countries.
“Consignment criteria” are part of rules of origin, which are the criteria to assess whether the goods maintain originating status for preferential tariff treatment while they are under transportation from a party to the other party: for example, list of permissible process, requirement of nonmanipulation certificate issued by transshipped countries, and so on.
Some flexibility may have been applied, for example, 10 percent deviation from the market price set by customs administration.
The official title is “Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994” constituting as an integral part of Marrakesh Agreement Establishing the World Trade Organization (adopted in 1994, came into force in 1995).
The European Union claimed that potential losses of customs duties and VAT due to undervaluation of imports of textiles and footwear from certain countries were calculated to be close to EUR 5.2 billion for the period 2013–16 (European Court of Auditors 2017).
“Push-type data exchange” means that the sender sends the data that are pre-agreed between the parties. “Pull-type data exchange” means that the sender sends particular data requested by the parties. 51 The Model CMAA is available on the WCO website. Weerth (2019) studied the number of CMAAs concluded by certain countries: United States (75), European Union (72), Turkey (63), Canada (42), Japan (19), India (12), United Arab Emirates and Argentina (11), Taiwan (8), South Africa (5).
