Tuesday, November 15, 2011

Free Trade Zones

Anyone that negotiates international contracts should know what free trade zones are and how they can be used. A free trade zone is an area designated by the government that exists prior to customs clearance for items being shipped into a country or after customs clearance for items being exported. It’s an physical area that normally consists of a large number of warehouses where access is controlled.Those warehouses may be operated by the government or by a third party. Many countries require that privately run warehouses be “bonded”.You can have goods be stored, have value added operations be performed all without payment of an import duty provided that any privately run warehouse puts up a customs bond.The liability under the bond is cancelled when the item is exported, withdrawn from the warehouse, destroyed, or imported and applicable duties are paid.

Since the free trade zone is technically not located within the country, purchases or sales that occur within those free trade zones are not considered local sales. They are considered international sales. As an international sale, a foreign company that makes a sale there does not have to be legally registered to do business within that country.Further as an international sale the seller is also not subject to that country’s laws or taxes. For exports held in warehouses, the Seller had to clear customs. The exporting seller would still be subject to local laws. How taxes on export sales that occur within a free trade zone may vary by country as to income tax treatment, but export sales that occur in free trade zones would normally not be subject to any sales or value added taxes as the sale is technically occurring outside of the country. Each country has their own rules on Free Trade Zones such as bonding requirements or the period an item may be held in a free trade zone. For example for U.S. free trade zones the maximum length of time the item may be held is five years.

While you can accomplish many o the same things by having sales and title transfer “when the product is on the high seas”, free trade zones can provide significant other advantages. For example, in Just In Time models, a supplier could establish a stocking hub in a free trade zone for pull by the buyer. The materials are being held closer to your point of use and the supplier has more flexibility. They avoid having to be legally registered to do business in that country and avoid being subject to that country’s laws and taxes. They would also be able to ship any excess stored product to other locations. If they imported the product to the stocking hub within the country, they would have to pay a duty that may not be recoverable if they exported it for use by other customers. They would also have to clear customs, By holding it in a free trade zone, no duty is paid until its imported and there is no issue shipping it to another country as it was never legally imported.

In addition to stocking hubs, you can use free trade zones to take advantage of low cost labor to perform things like repairs or value added activities. If you brought the item into the country you would need to have paid an import duty, which can be high in some countries. When you turn around to export it, you may not recover the full value of the duty paid and the recover process can be lengthy. If you have those activities be performed in a free trade zone, you never paid those duties in the first place. For example, you could have a repair operation where bad circuit cards were shipped to a free trade zone located in a low cost labor country and have individuals cannibalize cards to create working cards for spare parts. As long as you ship both the repaired card and the cannibalized card out of the country, you get the benefits of the low cost labor without needing to be registered to do business there.

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