Another Boston Tea Party? How Trump’s Tariffs Threaten to Upend Business Planning

Singer BJ Thomas had a hit in 1969 with “Raindrops Keep Falling on My Head”. Today though, tariffs keep falling on the heads of U.S. trading partners. How can businesses keep ahead of this? Import less, reshore more? Should inventory-heavy companies change their accounting methods (Last In, First Out vs First In, First Out) to reflect the change in pricing? 

A lot of eyes will be turned to the White House, observed Luis Abad, an international tax principal at KPMG.

“Businesses should regularly and closely monitor the tariff pronouncements from the White House. While the tariffs themselves are grabbing the headlines, the devil is in the details and compliance has become increasingly complex given some of the technical nuances surrounding implementation,” said Abad. 

Similarly, he added, the Section 232 “national security” tariffs on steel and aluminum products, means importers “are now required to trace the steel and aluminum in covered products to the country where the steel was melted and poured, or where the aluminum was smelted and cast. This is no easy exercise, particularly if the importer was not required to provide this data previously.” 

His advice: “Coordination between operations, systems, personnel and a company’s trading partners within the global supply chain. Businesses should stay ahead of these developments by modeling out in advance how potential tariffs may impact their business as soon as practicable and focus on those products or supply chains that may get hit the hardest.” 

Because the tariffs are cumulative — with a 25 percent Section 232 tariff imposed on derivative goods containing steel or aluminum, regardless of their country of origin, and additional hikes on goods from China that are “stacked on top of the ordinary duty rate that would be applicable to the imported good, this can become very costly for the importer,” Abad detailed. “And if the goods cannot be sourced domestically then they have few options. Reshoring manufacturing to the United States is not always a practical solution because it can take many years and a significant investment to start up a manufacturing facility in the United States, without any guarantee that the tariffs will not be transient.”  

That’s because President Donald Trump, or his successor, “may remove or significantly reduce the tariffs depending on trade negotiations or changes to the underlying economic conditions, thereby potentially making that reshoring decision competitively disadvantageous in the long run,” explained Abad. “Similarly, near-shoring or ‘friend-shoring’ to other countries may not provide complete relief since some of these tariffs are being imposed on goods imported from all countries, or on our closest allies and trading partners.” 

Abad and his KPMG colleagues are offering potential mitigation strategies to clients.

“One is to use the lowest price in the foreign supply chain as the customs valuation basis for the tariffs,” he explained. “This is known as the ‘first sale’ or ‘earlier sale’ strategy.” 

He illustrated the concept with an example: “If a foreign producer in China sells a product to a foreign middleman in Switzerland for $70, who in turn resells the same product to the U.S. importer for $100, the tariff – 25 percent in this example – would generally be assessed on the $100 price paid by the U.S. importer, resulting in a $25 tariff cost and a total landed cost of $125.”  

But, if certain legal requirements are satisfied, “the U.S. importer could use the $70 in the ‘earlier sale’ or ‘first sale’ transaction between the foreign Swiss company and the Chinese producer as the tariff basis, resulting in a lower $17.50 tariff bill for the same exact import transaction — with a total landed cost of $117.50, instead of $125.00 There are several lawful mitigation strategies that importers could consider such as this, but it all starts with first modeling out potential tariff costs, using accurate data, and then assessing the return on investment, factoring the cost of compliance, to implement the strategy.” 

Companies do not want to be caught flat-footed during this time of change. “Businesses are finding it challenging to keep ahead of the administration’s tariff moves because it’s a very fluid situation,” observed EisnerAmper audit partner Blair Robbins.  

DEALING WITH ZIG-ZAGS 

For example, soon after imposing sweeping levies of 25% on Mexico and Canada, the president effectively reversed himself, signing executive orders suspending tariffs on many imports from the two nations. Trump characterized the move as using a scalpel instead of a hatchet to resolve disagreements with big trading partners. 

“One strategic move we see companies making is to ensure they have enough U.S.-landed inventory to weather the storm of uncertainty and not be caught in a situation where their pricing to customers becomes too volatile,” Robbins advised. “That should enable you to ride out the tariff uncertainties until we get more clarity.” 

He illustrated that strategy by highlighting a Central New Jersey-based client, “with multi-national locations and more than 200 employees, which imports finished industrial goods and components for resale to food service and construction companies across the United States.” 

Even before the sweeping tariffs on China, “Our client had been working to ensure sufficient inventory levels to allow a measured approach to price fluctuations,” said Robbins. “Most of their product is sourced from overseas and a significant impact to the landed cost of goods means the company will need to deploy an array of countermeasures, including price increases.” 

But building up inventory “is not easy right now, since plenty of other companies are following the same strategy and, as a result, overseas suppliers are suffering production pinches,” he added. “Also, capital-intensive manufacturing and other companies that try to bulk up their inventory levels have to contend with cash flow and interest rate concerns, so it can be a bit of a balancing process.”

He thinks that the tariffs may ultimately drive some sourcing changes but believes change will not come quickly.

“India comes to mind as a possible alternative to China,” said Robbins. “Until now, India has more commonly been seen as a technical and professional services provider, but it could increasingly be viewed as a competitive manufacturing source. Still, it’s not as simple as just finding another low-cost and lower-tariff country. Businesses also have to consider cost structures like material, labor and shipping costs; but importantly, you also need to evaluate your potential partner’s quality control. And finding the right local partners for procurement and engineering can be time consuming. So, the whole concept of resourcing means being committed to a long-term process.” 

A wide swath of companies are struggling with the “fluid situation” of shifting tariffs, noted Aprio Tax Director, Tariffs and Customs Jay Cho. “Right now we’re helping them to assess their current situation. “Many life sciences businesses in particular, have relied heavily on Canada and Mexico for raw materials and manufacturing, and potentially heavy tariffs could disrupt these supply chains and squeeze their profit margins.” 

This could prompt businesses to take a closer look at the cost structure of their imported goods.

“When most imports from countries like Canada and Mexico were basically duty free, there was little to no visibility into pricing,” he explained. “But now businesses want to see if they can unbundle certain costs, like buying commission and administrative fees, that will generally not be subject to tariffs.”  

Companies that have facilities overseas and in the U.S. may also be able to mitigate their tariff hit by reassessing their customs value and transfer pricing, Cho added. “If you have related parties, you may have more flexibility to negotiate new pricing with your overseas partner – within the bounds of customs valuation rules – but you have to be careful to conduct a thorough customs valuation study and document your reasons for the transfer pricing changes. Both customs and the IRS have stiffened their investigations of transfer pricing arrangements and could challenge ones that do not reflect ‘arms-length’ pricing.” 

Cho is already assisting one of his clients, which imports materials from the U.K., in such a review.

“We’re reexamining the bill of material with an eye to possibly carving out certain non-dutiable cost elements – like international shipping costs or intellectual property not related to imported merchandise – that were previously baked into the overall material cost but are not directly tied to production or importation of goods. Of course, when you engage in a customs valuation/transfer pricing strategy, you should also consider the income tax implications, since a pricing reduction on imported goods for related parties will generally mean more income for the party receiving the goods. So, you cannot do a knee-jerk reaction; a multidimensional analysis is instead necessary.” 

NO SHORTCUTS 

KPMG’s Abad also has a warning for businesses that think there’s an easy way to circumvent expansive tariffs.

“The ‘country of origin’ of an imported product is important, because many of the tariffs are applied on a per-country basis,” he cautioned. “Some companies think that they can avoid tariffs on goods “by merely transshipping them from the country of production through another third country. However, transshipment – or the country of last exportation to the United States – does not determine the ‘country of origin’ of the imported product, and that practice may be unlawful if the incorrect origin is declared to [U.S. Customs and Border Protection] potentially subjecting the importer to financial penalties.” 

 The CBP has a real interest in determining the correct country of origin, “which is generally where a product is grown or produced,” Abad continued. “This determination, however, can be complicated and requires an understanding of various applicable legal standards, because components that are used to produce a finished good can be from various countries, and the final step assembly operation for the finished good may not necessarily result in a substantial transformation of those components.” 

For example, “A Chinese company might move the final assembly operation to Mexico to avoid tariffs on Chinese goods, only to discover the Mexican-assembled goods are still considered Chinese for U.S. tariff purposes, because the key components used to produce the finished good are Chinese, while the Mexican operations are simply assembly. Thus, importers need to correctly figure out what the country of origin is for imported goods, to avoid unnecessary costs and potential penalties.” 

EFFECTS ON RECORDKEEPING 

CPAs have to stay nimble to account for the fast and furious tariff shifts, according to Blair Robbins, an EisnerAmper audit partner.

“Generally, companies account for their inventory at the lower of cost or net realizable value,” explained Robbins. “Those costs include any applicable tariffs. Having a higher degree of volatility in the landed costs of goods causes highly fluctuating markets as competitors within an industry segment all adjust to the impact of the changing landscape differently. This will create a need for inventory cost accountants to stay on top of any impairment considerations.” 

The accounting can get even more complex if a business is engaged in contracts with customers where revenue is recognized over time, as the amount of revenue recognized is generally driven by the amount of total cost as a percentage of total expected cost to be incurred under a contract.

“Depending on the specifics of the contract, the burden of increased tariffs could result in changing estimates of revenue recognition,” Robbins noted. “Higher tariffs can also erode company forecasts for future cash flow projections, impacting goodwill impairment considerations.” 

And inventory valuation can directly impact a business’s reported profit or loss, since the price of the inventory is recognized as a component of cost of goods sold. So some businesses might be tempted to game their P&L by changing their inventory reporting from Last In, First Out – which, when prices are rising, generally results in higher reported cost of sales and lower profits – to First In, First Out – which may result in lower reported cost of sales and higher profits when inventory costs are rising. 

But Robbins said there is a cost-benefit of such a switch, and it may not make sense for many companies.

“Recordkeeping for LIFO inventory is complex and can be expensive and time consuming to implement,” he explained. “Given the rapidly changing landscape for tariffs, I suspect we will see most companies give things time to settle in before making any significant changes in inventory costing methods.”