Customs Coming Back Around on Compliance Audits
by Daryl Moore
(originally published as “Customs Coming Back Around on Compliance Audits” in Practical Trade and Customs Strategies, June 15, 2013, vol. 2, no. 11. © 2013 Thomson Reuters)
As long as there have been tariffs levied on imported goods, the U.S. government has worked to make sure importers pay the full extent of what they owe. That responsibility has historically resided with U.S. Customs, which has utilized different types of audits that have been received with varying degrees of enthusiasm by the trade community. The emphasis of Customs’ audits has gradually shifted over the years, from intensive transactional testing to risk-based evaluations, and may now be ready to swing back the other way. In this article we’ll review a bit of the recent history of Customs’ compliance audits, explore some of the changes that may be in store and examine how companies should prepare themselves to avoid and respond to an audit.
History. Two decades ago, the majority of Customs’ audit work came from referrals. Perhaps an official from the local field operations or enforcement office identified a known or perceived problem with an importer, or a disgruntled employee informed on his/her company to the feds. There was a widespread “gotcha” mentality that put a premium on using audits to ferret out bad actors and assess harsh penalties.
Things changed for the better after implementation of the Customs Modernization Act of 1993, which brought about a fundamental change in the way the import community interacts with Customs. Compliance was now a shared responsibility between Customs and importers: Customs made more of an effort to educate importers about compliance issues, while importers agreed to exercise reasonable care in conducting import transactions and to maintain adequate records to support their decisions.
Customs thus moved to a system of compliance assessment audits that evaluated importers’ compliance procedures and then statistically sampled and tested an average of 220 entry lines. Once the review was complete, Customs determined the extent of any noncompliance, estimated the total amount of revenue due, and designated the importer as low, moderate or high risk, which had a direct impact on the number of inspections and compliance exams the importer received at ports nationwide. Customs also adopted a risk-based approach to selecting importers for audits that involved analysis of nearly 30 import attributes and characteristics. Those companies that had not been recently audited and had the highest risk scores were selected for a compliance assessment audit.
Within just a few years, however, importer concerns prompted Customs to replace compliance assessments with focused assessments (FAs), which are designed to be less intrusive and to instead emphasize assessments of risk based on evaluations of internal controls. Customs can engage in more extensive compliance testing if an FA reveals an unacceptable risk but can also shift the burden to the importer by requiring it to develop a compliance improvement plan that determines the extent of noncompliance and sets forth ways to strengthen internal controls accordingly. The FA process generally encourages importers to take a more active role in identifying and remedying problems, including filing prior disclosures.
But old habits die hard, and Customs ended up adding another tool, the quick response audit (QRA), that often involves significantly more testing and sampling to home in on a particular objective or risk area. QRAs are always the result of a referral to address a perceived or known problem and are less about internal controls and more about uncovering specific evidence. As a result, QRA auditors tend to exhibit less flexibility and recommend more enforcement actions as may be deemed appropriate by Customs under the circumstances.
Possible Changes. Now, a variety of factors could be pushing Customs even further back in the direction of a more traditional audit approach, although this time there is a twist. A majority of the largest importers have become well-known to Customs through the FA program as having implemented systems and controls to manage their risks. These same companies tend to be participants in the Customs-Trade Partnership Against Terrorism and, to a lesser extent, Importer Self-Assessment programs, which gives Customs additional visibility into their operations. Customs is also standing up ten Centers of Excellence and Expertise around the country to better understand specific industries and identify compliance problems, an initiative also expected to predominantly benefit larger importers.
With larger importers thus generally becoming subject to fewer audits over time, it would be a logical step for Customs to resume a more hands-on approach to auditing for small and medium-sized importers. For example, the agency may look to streamline its internal control surveys for these companies to identify areas of risk and then do its own testing and sampling early in the audit process to determine the extent of any noncompliance and calculate any monies owed. The identification of specific problems could also yield an increase in the use of QRAs, with more enforcement actions taken in support of audits.
Other factors suggest such a change as well. For one, Customs officials have expressed concern that some importers are making the same kinds of mistakes despite the proliferation of tools designed to help them, prompting consideration of whether a more traditional audit approach with more testing is needed. In addition, Customs is facing a continuing decline in the number of auditors in its ranks as well as budget cuts mandated by sequestration, making a more effective use of resources a higher priority.
Preparing for and Surviving an Audit. Regardless of the frequency and methodology with which they are or may be conducted, audits can be a major headache for any importer, which is why proper preparation is key.
The first and most important step is for the importer to establish a vigorous system of internal controls over its customs-related activities, document those controls in a compliance policies and procedures manual, and then put them into effect. Internal controls can be seen as a process that permeates every level of an organization and is designed to provide reasonable assurance regarding the achievement of objectives concerning the effectiveness and efficiency of an importer’s operations, the reliability of its financial reporting and its compliance with applicable laws and regulations. Properly communicated and implemented, effective internal controls can foster a culture of compliance that will yield numerous benefits aside from demonstrating reasonable care, including increased business certainty, greater consistency and uniformity, improved efficiency and lower costs.
Next, importers will want to assess their compliance risks and come up with a plan to address them. Risks can relate to factors such as the valuation and classification of merchandise, claims for duty preferences under free trade agreements or other programs, liability for antidumping or countervailing duties, intellectual property rights, and maintenance of appropriate records. Each importer’s risks are unique to their business, so they should take the time to become familiar with their operations and all the rules and regulations that apply.
This evaluation shouldn’t be just a one-time event. All importers should conduct periodic risk assessments – annually, if not more frequently – to take account of any changes their business may have experienced. They may have seen an increase in CF-28s or CF-29s or had to file prior disclosures or post-entry amendments. Maybe they’re looking to participate in a Customs partnership program, become a member of one of the new CEEs or start taking advantage of a duty preference program. Perhaps their products fall within the scope of one of Customs’ priority trade initiatives or have come under congressional scrutiny for one reason or another. Or there may have been significant changes in their import processes or supply chains, such as opening new factories overseas, importing new items, switching customs brokers or purchasing new business units. Each time an assessment is completed, the information gained should be used to make any necessary modifications to the importer’s compliance manual and risk management plan.
Once this foundation has been established there are other steps importers can take to ensure they’re ready should an auditor come knocking. Designate a central point of contact for all Customs inquiries and implement activities to ensure the information reported to Customs is complete, accurate and timely. Develop strong lines of communication with all internal and external stakeholders – management, other departments (finance, purchasing, logistics), service providers (attorneys, consultants, brokers, forwarders, etc.) – in regards to customs activity. Monitor and evaluate progress and compliance on a regular basis by conducting post-entry reviews or periodic self-audits and making any corrections necessary.
A final note: Don’t hesitate to get help. Customs rules and regulations are complex and ever-changing, and it’s a challenge for even the most seasoned importer to keep the i’s dotted and the t’s crossed. Seek expert assistance or use third-party services to navigate the steps outlined above. Compliance review programs can be a time- and cost-effective way to assess customs-related risk, establish compliance priorities and develop an action plan to manage and monitor the identified risks. International trade counsel can also be a crucial ally during an audit by helping importers understand what Customs is looking for, explaining possible outcomes and resolving any disputes that may arise. Seeking expert advice for controversial or complex issues, as well as having outside experts as another set of eyes to periodically review internal controls, is a critical aspect to demonstrating reasonable care.