Unpacked: What is the ‘first sale rule’ and can it reduce tariff costs?
As retailers and brands grapple with ever-changing tariff policies, some are exploring workarounds to reduce their import duties as much as possible. One solution that has emerged in recent months is the “first sale rule,” a U.S. customs doctrine that allows importers to calculate tariff duties based on the original price paid to manufacturers.
This workaround can be advantageous for brands that import from major manufacturing hubs in Asia, particularly China, and can potentially reduce their tariffs. But as a major caveat, experts emphasize that the imported shipments must meet several criteria to quality. For example, the inventory can’t be part of an open production that any merchant can purchase, and must be specifically produced and destined for the United States importer involved. The companies that want to use the first sale rule must also be ready to provide U.S. customs with production and financial documentation to meet these regulations.
How the first sale rule works
Kirthi Kalyanam, a distinguished professor and executive director of the Retail Management Institute at the Leavey School of Business at Santa Clara University, said the first sale rule has specific qualifications that importers must adhere to to qualify.
For one, there are at least three parties involved in the sale: a manufacturer, a distributor, and an importer. “The importer is in the United States, and they are the ones who will use the first sale rule at customs,” Kalyanam said. The distributor is some kind of middleman and is typically located outside of the U.S., along with the manufacturer.
“Suppose a T-shirt is manufactured in China and sold to a distributor for $5 and the distributor sells to the importer for $10,” Kalyanam said. “Under the first sale rule, tariffs [rate] can be paid on the $5 of first sale.”
However, the importer must meet the following conditions: First, the product must be specifically produced for the U.S. importer and not as an open order for any merchant to buy. Secondly, the importer has to file a document that reveals the product’s specifications and the first sale price. “They have to obtain these documents from the manufacturer and the distributor,” Kalyanam said.
With those conditions comes a number of challenges and key issues that modern retailers and brands have to work out.
The most obvious is that distributors overseas do not typically provide customers documentation that reveals the first sale price they paid. “They do not want to reveal that price as this will reveal their margins and will cause bargaining problems,” Kalyanam said. Moreover, if the item was bought by the distributor in bulk and not specifically produced for the U.S.-based brand that’s importing it, it will be difficult to claim first sale.
How businesses can leverage the first sale rule
Indeed, startups and indie brands exploring the program are being cautious. One brand executive who spoke to Modern Retail said the company is looking into first sale tariff rates for their next shipment. However, the exec said many people in retail don’t feel comfortable talking about their process publicly. “It still feels a little gray,” the executive said.
Still, logistics players and customs brokers say they are seeing an uptick in interest in the first rule program from retail companies.
Ed Fitzgerald, vp of trade services for the Americas at logistics company Geodis, told Modern Retail that over the last several months, many importing businesses have been inquiring for different ways to legally reduce their tariff costs.
The first sale program, Fitzgerald said, is one of the popular programs importers are looking into. “As a customs broker, we’ve historically seen the first sale program used by apparel and footwear because those duties have been traditionally higher,” Fitzgerald said.
Fitzgerald said U.S. customs will continuously run various audits and may request documents, like financial and production records, to ensure the importer is meeting the regulations. For brands that want to start the process, Fitzgerald said the first thing they need to know is “who you’re buying from and the validity of your partner or your supplier.”
“We also recommend that importers have representation in that origin country that would provide that third-party validation on your behalf,” he added.
However, Kalyanam said, “Supply chains in China can be notoriously complex with inventory coming from multiple manufacturers.” That can make identifying and tagging inventory for “first sale” qualification difficult for smaller companies or startups.
While large retailers like Walmart and Gap can directly deal with manufacturers to leverage first sale law at customs, smaller retailers and brands may not find the hassle worthwhile. “I fully expect that a lot of murky documentation will be produced in the short term, and I fully expect that a series of legal challenges will occur from all of this,” Kalyanam said.
But for companies that qualify and go through the process, first sale tariff rates can save them thousands of dollars. For smaller businesses, that can make a big difference in their margins. “It’s definitely a program that importers should explore,” Fitzgerald said.