Controlling the zone

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Over the past decade, challenges to consumer protection have grown in step with the acceleration of international transactions, the growth of sprawling international supply chains and the proliferation of online shopping. As a result, there has been a dramatic increase in the volume of products moving globally, which has created supply-chain vulnerabilities. In a study by Frontier Economics, commissioned by the International Chamber of Commerce’s Business Action to Stop Counterfeiting and Piracy (BASCAP) and INTA, it is estimated that the total global economic value of counterfeiting and piracy could reach $2.3 trillion by 2022. This chapter is based on information from BASCAP’s 2016 Executive Summary and Recommendations for Controlling the Zone: Balancing Facilitation and Control to Combat Illicit Trade in the World’s Free Trade Zones.

What is a free trade zone?

A free trade zone (FTZ), also called a foreign-trade zone, is an area within which goods may be imported, handled, manufactured or reconfigured. Only when the goods are moved to consumers within the country in which the zone is located or re-exported do they become subject to the prevailing customs duties. FTZs are usually organised around major seaports, international airports and areas with many geographic advantages for trade. Examples include Hong Kong, Singapore, Colón (Panama), Copenhagen, Stockholm, Gdańsk, Los Angeles and New York City.

The primary purpose of an FTZ is to contribute to a country’s economic growth. Governments increasingly promote trade by creating FTZs as free-trading areas within a national border where a minimum level of oversight occurs. FTZs attract employers, stimulate the area’s economy and promote economic growth for the host country by increasing foreign investment, employment, innovation and technological development.

Exploitation of FTZs

However, insufficient oversight is a major enabler of counterfeiting. Along with the recent global proliferation of FTZs has come increasing vulnerability to a wide range of abuses by criminals who have taken advantage of relaxed oversight, softened customs controls and the lack of transparency in these zones. The reason that FTZs are so popular – the relaxation of regulations and oversight of operations – has also made them attractive to criminal networks and those involved in the manufacture, packaging and distribution of counterfeit goods.

According to the 2010 Organisation for Economic Cooperation and Development’s (OECD) Financial Action Task Force report on ‘Money Laundering Vulnerabilities of Free Trade Zones’, once in an FTZ, goods may undergo various economic operations, including assembly, manufacturing, processing, warehousing, repackaging, relabelling, storage and further shipment. In an unregulated FTZ, counterfeiters can manufacture goods from raw materials or sub-components, just as they would outside the FTZ. Within FTZs goods can be misrepresented as trans-shipped from a country of legitimate production. Methods of deception range from straightforward smuggling in containers with false walls and cover-loads to misdescriptions of goods. In some countries, shipping forms do not have to show brand names. Counterfeiters exploit this relaxed shipping policy by listing descriptions that do not correspond with the actual goods. Some domestic and FTZ-related companies can even be unwitting partners to counterfeiting. A printer, for example, may produce trademark-infringing packaging materials under the direction of third parties purporting to be legitimate licence holders.

Additional difficulties arise when FTZs share a physical territory with a residence population that consumes goods in the zone and where the FTZ is also a shopping location for visitors. Commercial quantities of pirated or counterfeit goods are brought to the FTZ with little or no customs supervision. They are further disguised for shipment to countries beyond the zone. Counterfeiters use FTZs to disguise products’ primary origin.

Tracking and treatment of shipped goods require coordination between Customs’ document management systems and FTZ administration. A lack of IT system coordination may not be a significant problem if Customs has access to FTZ automation systems and company systems in the FTZ, so that reusable IT data can be exchanged. Without coordination or access to data by Customs, however, FTZs are easy targets for re-documenting shipments and hiding the origin, content and destination of illicit goods. These covert operations allay the suspicions of Customs in subsequent transit ports and final destinations, turning zones into both laundering and distribution points for counterfeit goods. Opportunities for counterfeiting, IP rights violations and other crimes are greatly reduced when the national customs authority works inside the FTZ and can periodically observe and review company operations.

Pressing need for action

A 2016 report by the OECD, in partnership with EUIPO, found that counterfeiting and piracy in international trade has grown from $250 billion annually in 2008 to more than $461 billion in 2013 – representing an increase of more than 80% in less than 10 years and representing more than 2.5% of world trade. Frontier Economics projected these findings into 2022 and reported that the international trade in fakes could be as much as $991 billion.

Further, a joint 2018 report between the OECD and EUIPO entitled ‘Trade in Counterfeit Goods and Free Trade Zones, Evidence from Recent Trends’ found that the existence, number and size of FTZs increases the value of counterfeit and pirated products exported by a given economy. The findings indicate that one additional FTZ within an economy significantly increases counterfeiting by 5.9% on average. The report also says that the establishment of a new FTZ in a given economy is likely to result in higher volumes of trade in fakes departing from this economy.

The study also found that lightly regulated zones are also attractive to parties engaged in illegal and criminal activities and that FTZs that are not policed adequately contribute to the facilitation of counterfeit and pirated goods. It determined that many zones have weak coordination between governments and zone operators, which exacerbates the problem and allows criminals to further exploit zones for illicit activities.

The September 2019 World Customs Organisation (WCO) Research Paper 47 entitled ‘Extraterritoriality of Free Zones: The Necessity of Enhanced Customs Involvement’, describes the involvement of Customs, or lack thereof, including procedures and controls. The report finds that Customs’ involvement in the operation of FTZs tends to be low level. Customs is not sufficiently involved in the establishment of FTZs or in approving companies that operate in them. It also found that due to Customs’ insufficient possession and utilisation of data, Customs controls inside FTZs often becomes ‘relaxed’. The report states that in some countries, Customs’ role is to conduct enforcement only at entry to or exit from FTZs, and it is not even allowed to enter an FTZ without concrete suspicion of illicit trade.

The WCO study also drew conclusions regarding the misconception that there is an ‘extraterritoriality’ of FTZs precluding customs officials from properly conducting searches and investigations. Specifically, Chapter 2 (Free Zone) of Specific Annex D to the Revised Kyoto Convention (RKC) defines a ‘free zone’ as “a part of the territory of a Contracting Party where any goods introduced are generally regarded, insofar as import duties and taxes are concerned, as being outside the Customs territory”. The WCO paper states that this statement is misinterpreted by many countries to mean that the entire FTZ is “outside of customs territory, not the concept that FTZ introduced goods are generally tax free”. The paper also states that “the definition laid down by the RKC merely states that ‘goods’ located in FTZs are regarded as being outside the Customs territory solely for the purpose of applying import duties and taxes, and means that an FTZ itself falls within the Customs territory, where Customs law should apply, and the usual Customs controls should therefore be applicable and be fully enforced”.

Best practices to stop FTZ abuses

Strengthen the relationship between Customs and FTZs

As noted by the WCO above, a common misconception exists that free zones are extraterritorial, outside of the nation and not subject to national customs or customs laws. This confusion lends to an environment that enables illicit activities to infiltrate the zones. The WCO has tried to correct this misconception by emphasising that goods are outside the customs territory “only insofar as import duties and taxes are concerned”. The RKC delineates a number of guidelines that address the evolving problem, including explicit customs jurisdiction over FTZs, rules on origin of goods and customs transit and trans-shipment procedures.

Unfortunately, accession to the specific provisions in the RKC for management of FTZs is optional to WCO member states. More signatory nations must implement RKC provisions that would substantially address the problem by giving full authority to Customs inside the FTZs, while requiring Customs to act in a transparent and professional manner to facilitate legitimate businesses.

Governments must empower national customs authorities

Countries should enact a wide variety of laws affecting the enforcement and protection of IP rights. For example, some countries empower Customs to control goods and activities in FTZs. Others have denied Customs jurisdiction over goods in FTZs because of a misunderstanding that an FTZ is a customs-controlled location. These countries operate under the premise that goods in FTZs are not clearing through Customs and are not being imported. Strong national IP rights legislation should apply to all customs regimes. A clear customs mandate should empower Customs with authority over all goods in the territory, including FTZs, which is key to combating counterfeiters and organised traffickers.

Simply passing laws and issuing regulations is an incomplete process until such measures are applied in practice. Furthermore, there are instances where, in some countries, the regulations are already in place but are not adequately applied. Countries are therefore encouraged to:

  • clarify that FTZs are outside of a national customs’ jurisdiction only insofar as duties and taxes are concerned;
  • clarify that FTZs remain under the jurisdiction of the national customs authority and that the national customs has unrestricted rights to enter and observe operations, audit the books and records of companies in the zone and validate goods status and conformance with tariff and non-tariff measures under the national customs mandate;
  • empower customs authorities with jurisdiction over FTZs’ day-to-day operations;
  • review and implement national IP rights legislation, follow WCO guidelines (including Specific Annex D of the RKC) and include language that makes legislation applicable to all goods in the national territory, in all customs regimes (including transit, in-transit and free-zone regimes);
  • ensure that strict penalties are in place, including criminal penalties where appropriate, against perpetrators of illegal activities in FTZs;
  • grant Customs ex officio power to detain goods suspected of infringing on IP rights, including goods in FTZs; and
  • enable cooperation between national customs authorities and the special authorities of FTZs or free ports to ensure efficient enforcement of anti-counterfeiting criminal and civil laws and to regulate the offences of trafficking in counterfeit goods.

To the greatest extent possible, the data systems of the FTZ operator tracking commercial activity and the national customs automated systems should be linked to directly transfer data on the activities in the zone. Without coordination or access to data by customs administrations, FTZs are easy targets for re-documenting shipments and hiding the origins, contents and destinations of illicit goods. Opportunities for illicit trade are greatly reduced when the customs administrations work inside the FTZ to observe and review operations.

Strengthen national government adherence to international conventions

International agreements and conventions – and adherence to these – have not kept pace with effective enforcement of IP rights in FTZs. While existing conventions cover most of what is needed, they suffer a number of limitations. Most notably, their minimum standards typically allow countries room for interpretation, which often leads to minimum action.

WCO’s RKC and the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs) address enforcement of IP rights protections and contain Customs-related provisions. The RKC adequately covers FTZs for control of goods, such as the right of Customs to enter and inspect goods in the zone for tariff and non-tariff conformance to laws and regulations. A weakness of the RKC is that its provisions for free zones are in a specific annex that is not mandatory for RKC contracting parties or all members of the WCO.

TRIPs provides comprehensive requirements for the protection of intellectual property, including border measures; however, it does not specifically address FTZs. In addition, some of its stronger provisions are not mandatory for WTO members. Consequently, the WTO should clarify that since TRIPs does not exclude FTZs, WTO members are obliged to apply TRIPs requirements to all FTZs within their territories. Improved customs enforcement depends not only on stronger provisions in international agreements, but also on countries’ adoption of these provisions into stronger laws. Those laws could incorporate flexibility into TRIPs to address many issues now. Moreover, courts can apply only the laws as they are enacted. A number of recent court decisions have upheld authority to regulate activity in FTZs, but judicial authorities in most countries cannot overcome limits on the reach of customs authorities proscribed in national laws.

Strike a balance between economic benefits and controls

To achieve what was intended for FTZs, there must be a balance between incentivising economic growth and maintaining jurisdictional, border and customs controls that prevent dishonest and harmful practices. Over-regulation stifles business development, growth and profitability; adequate and proper regulation promotes it by creating a predictable environment and by discouraging unfair and predatory acts. Today, in the shared customs-to-customs community, now known as global Customs, authorities have the power and responsibility to punish bad actors and to recognise and reward compliant actors in international trade supply chains.

WCO’s SAFE Framework represents one such example. Compliant traders – or authorised economic operators (AEOs) – receive beneficial customs treatment, including fewer or no inspections on goods imported or exported by or via the AEO, resulting in quicker customs clearance and lower operator transport costs. FTZs and the companies in the zones can join in receiving such benefits only if Customs is fully functional inside the FTZs. When customs authorities are unable to exercise their due responsibilities in FTZs, bad practices proliferate. This problem is particularly acute where goods are beyond the reach of customs authorities and other law enforcement bodies while transiting, in-transit or in free-zone status. Consequently, violators are free to act without fear of legal penalty.

As such, FTZ operators are encouraged to:

  • self-regulate to prevent piracy and counterfeiting (eg, conduct standard due diligence in accepting businesses into zones);
  • allow and encourage national customs authorities to evaluate the zone via physical observation of operations and verification of compliance with tariff and non-tariff requirements;
  • demand that national Customs apply best practices in exercising authority in zones (eg, use ordinary company records as primary control documents in determining customs free-zone status and in changing the customs regimes);
  • consult with the customs authority for AEO recognition if the national government has committed to WCO SAFE Standards and has an AEO programme (if the country has notified the WCO of its intent to follow SAFE, but the national customs authority does not yet have an AEO programme, encourage the authority to meet this commitment); and
  • for ease of goods status validation, consider the interface and exchange of data with the national customs automated systems and recommend that FTZ companies do the same.

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