Abstract

The centerpiece of effective customs modernization is a shift away from physical controls at the point of entry and toward the use of checks after goods have been released from the port. This chapter sets out this approach to revenue collection and trade policy administration.

The centerpiece of effective customs modernization is a shift away from physical controls at the point of entry and toward the use of checks after goods have been released from the port. This chapter sets out this approach to revenue collection and trade policy administration.

This approach is particularly effective for verification of valuation, tariff classification, origin—increasingly important, given the proliferation for regional trade agreements described and discussed in Chapters 1 and 2—and entitlement to exemptions. Undertaking most, if not all, verification activities when the goods are under customs control (that is, prior to release) is no longer appropriate, given the need for customs administrations to become more efficient, the demands of the trade community for better service and lower costs, and the increasing complexity of import and export transactions. Most modern customs administrations have recognized this fact and developed a control strategy that combines selective, risk-based controls before the goods are released with post-release verification and audit.

A. Pre-Release Controls and the Need for Post-Release Verification and Audit

The compliance control strategy of a customs administration for commercial importations normally involves five steps.75

Step 1: Cargo reporting

For all modes of transport (i.e., air, sea, rail, and truck), the carrier is required to report to the customs administration the goods that are being brought into the country. This initial cargo report from the transportation company is usually in the form of a customs manifest. At this point in the process, there is limited information available concerning the value and tariff classification of the goods. The cargo report creates an inventory of goods that have entered the country and that are awaiting further processing (e.g., transit through the country, entry for consumption, temporary admission for further processing, reexport, etc.). All of the goods in the inventory must be accounted for within a specified period of time.76 Key features arising at this stage, the control of manifests, are discussed in detail in Chapter 4.

Step 2: Declaration processing

The declaration (paper or electronic version) is the most important document in the customs process. In itself, it is simply a summary of the information contained in the supporting documentation, such as the commercial invoice, packing list, exemption authorization, certificate of origin issued in the country of export, and so on. Under a self-assessment system, the importer or agent certifies to the truthfulness of the declaration and the supporting documentation.

The declaration is thus the importer’s statement of the circumstances surrounding the goods being imported and the treatment that is being requested for them.77 For many transactions, this includes the calculation of the duties, taxes, and other fees payable. For other transactions, an exemption may be claimed and the declaration will summarize the reasons for the exemption claim. The information on the declaration is critical. It is used to conduct verification activities prior to the release of the goods—including ensuring that certain documentation has been presented (for instance, certificates from the departments of agriculture, health, and other government departments for certain goods)—and to select goods for physical inspection. And it is also the basis for post-release verification activities and the preparation of trade statistics. More generally, the information on the declaration should be used carefully to determine how a particular shipment should be treated, with an increasing number of countries using automated techniques of risk assessment for this purpose; see Box 5.1 for a description of these techniques.

Risk Analysis for Selective Verification

Selection of declarations for physical inspection and/or documentary controls should be based on simple risk evaluation criteria combined with in-depth study of international trade databases, the objective being to be able to predict the risk of fraud. Risk evaluation can support three levels of control: (1) “green channel” (no controls), (2) “orange channel” (documentary controls), and (3) “red channel” (documentary controls and physical inspection of goods).

The selection system for shipments to be physically inspected should focus on the most important elements of the international trade transaction, which are (1) the origin of the goods and the routing of the shipment; (2) the type of goods; and (3) the importer, exporter, and others involved in the transaction.

The essence of the system is an automatic mechanism for selecting transactions. Each criterion (i.e., operators, goods, and routings, singly or in combination) is graded on the basis of available statistical information as to how good an indicator it is of the potential for fraud. An overall “score” for the level of risk in any particular declaration is then obtained by totaling the weighted scores attributed to the various criteria (the weighting coefficients being established by econometric analysis of data from previous declarations, with more weight given to those criterion that are the best indicators of risk). The declaration is then assigned to the appropriate channel based on the assigned score: highest risks to red, lowest risks to green. (The weights should of course not be made known to traders, since that would enable them to manipulate the perceived risk of their transactions.)

In addition to the selections made automatically in this way, additional declarations should be selected by these further criteria:

  • Verification all new operations, meaning those that involve an operator, a good, or a routing that is not known in the database. For example, if the declaration contains a false importer identification code, the declaration will be reviewed intensely and the shipment will be physically inspected.

  • Mandatory selection for documentary review and/or physical inspection of certain transactions based on one or more of the characteristics on the declaration (e.g., block the release of a shipment pending an inspection by the health or agriculture department). Selection may also be triggered if, for example, goods for a certain importer have not been physically inspected for several weeks.

  • An element of purely random selection, which provides a risk of inspection for all declarations and also helps to maintain and update the database on which the selection mechanism is built.

It is essential that the results of the documentary reviews and physical inspection are recorded in the system, so that the risk analysis system always make use of the latest information.

Step 3: Physical inspection

Physical inspections have a role to play in verifying quantity, ensuring that the description of goods is sufficient for tariff classification, detection of contraband, and the enforcement of laws and regulations not related to revenue (for example, phytosanitary, drugs, intellectual property rights, and control of endangered species). Physical inspections are less effective for valuation, tariff classification, origin, and exemption determination that are dependent upon the terms of sale, detailed technical descriptions, the presence of certificates or letters of authorization, etc. (i.e., information that is normally available from the books and records of the importer). Therefore, these inspections should be targeted at high-risk shipments where there is some expectation that the suspected violation can be detected through physical inspection (e.g., certain importers may have a history of misdescribing goods on the declaration to attract a lower rate of duty).

Step 4: Post-release verification and audit

This activity is best suited to detecting violations that have a direct impact on revenue, including undervaluation, tariff misclassification, origin fraud, and illegal use of exemptions. It relies heavily on the analysis of information both from the declarations themselves and from other sources (e.g., tax department) to assist in detecting areas for review. As with physical inspections, a risk-based approach should be used to identify the transactions and companies that should be subject to full review. For example, in order to determine the customs value of the goods under the WTO Valuation Agreement, it is necessary to ascertain certain facts about the transaction (such as the relationship between buyer and seller). The information may not be readily available prior to the release of the goods and can only be determined through correspondence with the importer or audit.

Step 5: Investigations

Serious violations occur in all customs systems and, for this reason, it is necessary to establish an investigation capability to detect fraud. Good intelligence is the key to effective investigations and, therefore, it is important that sources of intelligence be developed both within and outside the country (most customs administrations have developed good working relationships with neighboring countries and other countries with which there is considerable trade activity). The analysis of information that is available from all customs activities (e.g., cargo reports, declarations, post-release reviews, etc.) is also an important part of this work.

The need for an emphasis on post-release controls

Even when the compliance strategy is based on the five steps just described, there remains the difficult issue of determining how the limited resources available to the customs administration should be allocated between them. This determination is not easy because the provision of good service to the trade community is becoming increasingly important and, at the same time, the verification activities of the customs administrations have become increasingly complex and, hence, difficult. The consensus is that there is a need for customs administrations to move away from the traditional approach of transaction-by-transaction processing to an accounts-based approach that relies on certain verification activities being undertaken while the goods are under customs control but with an emphasis for revenue-related verification on post-release controls, including the audit of the books and records of importers. For many administrations, this is a dramatic shift in emphasis as they have been used to intensive verification activities before release of goods (including in some developing countries some level of physical inspection for 100 percent of declarations). In some countries, the legislation does not anticipate the need for post-release verification and audits as a routine matter but only in cases where fraud is suspected; this is very different approach from that in most modern tax legislation, which is based on self-assessment-supported verification through audits and routine reassessments. While it is difficult to specify a percentage of activities/resources that should be used in the post-release verification activities, it would not be unreasonable to assign 50 percent of the total number of professional personnel dedicated to the processing of commercial transactions to post-release verification and audit.

B. Organization and Procedures

Post-release verification and audit is thus an essential part of the overall compliance verification strategy. For the program to be effective, it is important that the post-release control units be properly organized and that procedures be developed to ensure that the appropriate amounts of revenue are paid.

Organizational structure

In most modern customs administrations, it has been recognized that tariff classification, origin claims, exemption verification, and valuation are sufficiently complex to justify employing specialist staff to undertake a detailed verification of import declarations in selected cases after the release of the goods. If this verification reveals that additional duties and taxes are due, then these will be collected along with fines or penalties where appropriate. It might also be decided to visit the trader to carry out a full audit to investigate whether or not the loss is one of a series, or perhaps a part of a systematic fraud, where there is a much greater threat to the revenue.

Classification, origin, exemption, and valuation checks are still an important part of the declaration processing system because these checks are related to the evidence available at the time, including the results of reviews of the documentation and physical inspection of the goods. However, an effective control strategy also recognizes the importance of highly developed post-release verification procedures.78

Teams are typically established on a regional basis and staffed with officers carefully selected on the basis of their experience, technical knowledge, and motivation.79 It is important to grade and pay the officers employed in the post-release control units at a higher level than the officers who perform the routine controls to attract more qualified members of staff to these positions. It will recognize the importance of this work and also give them status among their colleagues, motivating other members of staff to acquire the same skills.

Systems need to be set up for the selection of declarations and importers and exporters for in-depth scrutiny and check. These factors, as discussed in more detail subsequently, include known high-risk tariff headings, goods that are frequently found to be undervalued, those that come from areas where origin is doubtful, and goods and importers claiming exemptions. The teams should be set up on the basis of individual officers working as specialists—taking the lead on several chapters of the tariff and being accountable for the proper application of the rules in that area. They should select and work on high-risk importers and exporters and organize verification activities related to targeted chapters of the tariff or declarations from selected countries (e.g., to verify origin).

Even though officers will have primary responsibility and will be accountable for a clearly defined area of work, they should work as a team. For example, an officer concentrating on high duty rates would be expected to work very closely with the valuation expert as the fraud or undervaluation may well be found in that area. In these circumstances, even if the declarations and supporting documentation appear to be acceptable, there may be justification to ask the importer for additional information or to carry out an audit of the books and records. If the records indicate that the trader is a regular importer and the duty potential of errors or fraud is high, this may require a team of two or three officers. The team will need expert knowledge of audit techniques, valuation, and tariff classification. The unit should work out an agreed management plan with clearly set aims, objectives, and targets, and regularly report on their progress.

Selection of transactions for review

Not all declarations will be reviewed after release. Therefore, the objective is to identify or select the declarations that should be reviewed, and the selection is usually related to the potential additional revenue that may be realized from the review.

Following the processing of the transactions at the local office and the release of the goods, the declaration is forwarded to the regional office to be filed. Prior to filing, it should be determined if the declaration meets the selection criteria for post-release review. If declaration processing at the local office is automated, selection criteria can be run following release, and the declaration can be forwarded to the region with a note that it has been selected.80 Even in customs administrations where declaration processing is not automated, there is usually an automated system that captures information from the declarations for trade statistics purposes. Criteria can be developed to select transactions for post-release review as the transactions are being entered into the trade statistics database.

The selection of transactions for post-release verification is normally made on the basis of the following criteria, either singly or in combination:

Importer taxpayer identification number.81 Importers with a history of false invoicing, undervaluation, and misdescription of goods should be identified as high risk and subject to a high probability of verification. For a period of time, all declarations from new importers should also be selected for verification.

Origin. The customs administration may have recurrent problems with goods from certain countries or may be required to verify origin in particular circumstances (e.g., goods from countries in the customs union). Criteria can be developed to target shipments from these countries for in-depth review.82

Tariff heading. Goods that are free or subject to low rates of duty should be reviewed for tariff classification purposes. On the other hand, goods with high rates of duty are more likely to be undervalued.

Exporter name. As with importers, certain foreign exporters may be high risk. There will also be certain domestic exporters who are not reliable and information from the tax department may be useful in identifying those exporters who are suspected of VAT fraud.

Value of shipment. Value will often be used as a basis for selection as high-value importations are an obvious risk category. Because the potential loss of revenue is less for low-value shipments, a “cutoff” limit may be used to exempt low-value shipments from close review. (This criterion must be used with care, however, since it gives importers an incentive to break up or misdeclare shipments so as to take them below the threshold. It may be wise, for instance, to keep this threshold confidential.)

Exemptions. While, at the time of declaration processing, the eligibility for an exemption is verified, there are certain exemptions that require follow-up after release. Declarations can be selected if the exemption was “conditional.” For example, there may be a need to determine if a “use” requirement has been met (i.e., importations where duty-free access is granted for certain goods that are to be used to manufacture other goods require the customs administration to follow up to determine if the goods were used as required). In other cases, goods are admitted free of duties and taxes for purposes of manufacturing exports (i.e., temporary admission), and follow-up action is necessary to ensure that all of the goods entered for this purpose have been used to produce exports (i.e., the imported goods were not diverted to the domestic market).

Random selection. Once the declarations have been selected based on the predetermined criteria, the remaining declarations not selected should be subject to random selection (at a rate of approximately 1 to 2 percent). The random feature is designed to sample declarations to assist in the identification of other risk areas that may not have been identified or to amend existing selection criteria—and, not least, to ensure that all importers are aware that there is some chance of audit.

As is the case with selection criteria used during declaration processing, it is important that the post-release selection criteria be reviewed and evaluated on an ongoing basis. The results of the reviews of the selected declarations should be recorded and reports produced that show their effectiveness. Full-time resources should be dedicated to the development and maintenance of the selection criteria.

In addition to selecting declarations for review after release, there will often be a need to search the database of declarations to retrieve those that meet certain criteria. For example, as a result of the review of one declaration from one importer, it may be found that goods have been misclassified. In this case, it will be necessary to retrieve and review all similar transactions for that importer for the period of time (e.g., for the past 6 to 12 months). It may also be desirable to review declarations for the same goods from other importers if it is suspected that the reasons for the misclassification by one importer may also apply to the others (e.g., the wording of a particular tariff heading is subject to misinterpretation).

Once the declaration and supporting documentation has been reviewed, it may be necessary to request additional information from the importer. For example, for transaction value,83 it may be necessary to determine the total payment made or to be made; the inclusion or exclusion of freight and insurance charges in the terms of sale; and, if the buyer and seller were related, whether or not this relationship influenced the price.84 In order to satisfy any questions concerning tariff classification, technical literature may be requested, for example in the case of textiles, it may be necessary to determine the exact mixture of man-made and natural fibers. In other cases, such as origin investigations, it may be necessary to contact the exporter and/or the customs administration in the country of export to request information to verify the importer’s claim for a tariff preference.

75

While the control of exports is important particularly to prevent fraudulent claims of zero rating for VAT, in general, more stringent verification efforts are required for imports for both revenue and protection reasons.

76

The customs law normally sets out the time periods for the required actions, for example, a declaration for goods for consumption may be required within 30 days of the manifest report while goods in transit may require an exit report within 5 days.

77

The WCO defines a goods declaration as “a statement made in the form prescribed by the Customs, by which the persons interested indicate the Customs procedure to be applied to the goods and furnish the particulars which the Customs require to be declared for the application of that procedure.” In most customs administrations, the declarations are prepared and presented by customs clearing agents.

78

This approach has proved to be very effective in the customs services of the United States and Canada. Import or commodity specialists located at regional offices and headquarters undertake these reviews. They are normally organized in teams by commodity (each specialist or group of specialists is made responsible for a certain number of chapters of the Harmonized System). In both countries, the specialists are at a higher grade and pay level than the officers working in the local offices. Officers working in the local offices are motivated to gain specialist knowledge in these fields as they see gaining one of these positions as an opportunity for advancement; this provides a major benefit for the administration.

79

For purpose of this discussion, it is assumed that the customs administration is organized in local offices reporting to a regional office that, in turn, reports to headquarters. It is further assumed that the post-release verification activity takes place at the regional office although this is not the case in all customs administrations. In some developing countries it may be more appropriate to implement the post-release verification activity at headquarters when there is a heavy concentration of import and export activity in one or two locations, usually including the city where the headquarters office is located.

80

Alternatively, when the transaction arrives at the regional office, before it is filed, the declaration number can be entered into the system and a message will appear to show whether or not it has been selected.

81

The customs administration should use the taxpayer identification number issued by the tax administration.

82

The mere presence of a certificate of origin is not sufficient, in all cases, to permit customs clearance at a lower, preferential rate of duty. Investigations of origin claims may be required in certain circumstances.

83

Under the WTO valuation system, transaction value is the primary method of determining the customs value of imports. See Chapter 6.

84

Of course, it will be very difficult for any customs administration to determine if the transaction has been made at “arm’s length.” The cooperation of other customs administrations may be helpful in investigations of this nature.

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