The Alchemy of the Duty Deferral Programs: Turning “Scrap and Waste” into Gold

Article by Bob Sacco, GTA Trade & Customs Practice Leader (KPMG) and Lisa Zajko, Trade & Customs Partner (KPMG)

There should be little doubt that the hastiness with which the Canadian government implemented surtax countermeasures on steel and aluminum products in response to similar US actions would result in some unforeseen challenges, and further unanticipated costs, in the administration of the regime. After all, the surtaxes that went into effect on July 1, 2018 were only proposed a month earlier, and stakeholders had a mere two-week window to provide comments for consideration. 

While it has only been weeks since implementation, importers and exporters affected by the measures have hurriedly been trying to minimize the effects of the surtaxes by applying for relief under Duty Deferral Programs (Duties Relief and Drawback Programs in particular) administered by the Canada Border Services Agency (CBSA). While these programs are not newly created for surtax purposes and, in fact, are long-established programs with structured approval and audit programs, the CBSA has experienced a significant surge in applications as a result of the countermeasures. Further, it has become apparent through discussions with government stakeholders that participants in these programs will face significant challenges in obtaining the full amount of relief that they may be entitled to under these programs due to relatively new, and more aggressive, administrative interpretations by the CBSA relating to the treatment of ‘scrap’ and ‘waste’. This change has the potential to generate significant duty (surtax) revenue at the expense of Canadian importers and exporters.

The issue stems from the fact that waste and scrap, whether merchantable or not, is treated differently than by-products under these programs, and is further exacerbated because these are not defined terms within the relevant customs legislation and regulations. When imported goods are further manufactured in Canada for export, and that production results in waste or scrap, the amount of any relief or drawback would generally include non-merchantable scrap or waste that is within acceptable industry standards. If the scrap or waste is considered merchantable (or beyond normal industry standards) and is not exported, section 122 of the Customs Tariff provides that the relief or drawback is reduced based on the value of the scrap or waste multiplied by the duty rate applicable to scrap or waste of the same kind. As the tariff items for waste and scrap metals are not subject to duty or surtax on importation into Canada, the effect of this provision is that production resulting in merchantable waste or scrap metals should not cause a reduction of the relief or drawback applicable to the steel or aluminum imported for processing and re-export. However, section 121 of the Customs Tariff provides that where the processing in Canada results in by-products, the amount of relief or drawback is proportionately reduced based on the relative value of the by-products that are not exported or otherwise eligible for relief. When applying the rule for by-products, the duties (or surtaxes) paid on the original importation of steel or aluminum is apportioned and, thus, surtaxes will apply to the by-products that are not exported. 

The CBSA has taken the position, reportedly based on discussions with the industry, that all excess or cut off materials and other items commonly referred to as scrap or waste within the industry are, in fact, by-products and should be subject to the surtaxes when they are not exported from Canada.

There are several concerns with this position taken by the CBSA. First, it is seemingly quite a departure from how this industry has been treated historically and how the CBSA has previously interpreted these terms. The CBSA’s own Trade Incentives Manual (April 2014) states that “scrap or waste is not a manufactured product”. It also provides a definition of scrap that refers to “odds and ends”, lists trimmings as an example, and includes a sample scrap statement covering turnings recovered from the machining of metal rods. Next, it is very difficult to understand what, if anything, would ever qualify as ‘merchantable scrap’ under the current CBSA position if the term by-product is being assigned to anything of relatively nominal value by virtue of the fact that it is recycled or sold. Third, it is simply not reasonable to consider that waste or scrap which must be further processed (e.g. melted down and combined with other metals) is, in itself, a commercial product other than merchantable scrap. Excess materials, trimmings and similar items that are sold at relatively nominal values, are not useable in their present form, and require further activities to convert them into a useable product, are more reasonably considered merchantable scrap. Finally, the CBSA interpretation actually encourages domestic producers to export their waste and scrap (to the detriment of domestic companies that acquire scrap for conversion to products); however, the commercial reality of this industry is that it is quite cost-prohibitive and impractical to do so.

At this point, many readers may be asking themselves what all the fuss is about if the waste or scrap at issue has nominal (or no) commercial value. Even the most rudimentary of arithmetic skills would support that anything multiplied by zero is zero; thus, if the waste or scrap has no commercial value, the duty or tariff impact of this issue would similarly be zero regardless of the tariff classification or duty rate applied. There are a few concerns with this line of thinking. First, in many cases waste or scrap is being sold for a value. While the value may be relatively nominal, this means there will be a tariff impact under the CBSA’s position. Further, discussions with the CBSA indicate that if a program participant does not maintain records supporting an approach to calculate duty (and surtax) owing based on relative values of the ‘by-products’ remaining in Canada, subsequent auditors may apportion duties payable based on relative weights rather than relative values. Given that the relative weight of metal scrap or waste can be quite significant, this would be much more detrimental to participants than relying on an approach using relative values. Finally, there has been some indication that the CBSA will not necessarily rely on the price at which the processor sold the merchantable scrap for in determining the relative value of the by-product. It appears that the CBSA may seek to apply an “industry selling price”, or market rate, rather than the actual selling price. Where the scrap, waste or by-product has been sold in an arm’s length transaction, relying on a market or industry rate would be directly contrary to section 120 of the Customs Tariff which defines the value to be the price at which the processor sold the by-product, scrap or waste. If the CBSA were to apply a market or industry rate, it could result in very significant reductions in relief (or repayments) – thus turning scrap and waste into gold. 

The definition of alchemy is ‘a medieval chemical science and speculative philosophy aiming to achieve the transmutation of the base metals into gold…’ Perhaps the philosophy is not so medieval?