Manufacturing Drawback Explained: Substitution vs. Direct Identification

Manufacturing drawback can allow eligible duties associated with imported merchandise used in U.S. manufacturing or production to be recovered when qualifying articles are subsequently exported or destroyed.

Under 19 U.S.C. § 1313(a) and § 1313(b), companies may qualify using either direct identification or substitution manufacturing drawback. The two methodologies differ in how imported or substituted materials are connected to the manufactured articles and in the records required to support the claim.

What Is Manufacturing Drawback?

Manufacturing drawback applies when imported duty-paid merchandise is used, or qualifying substitute merchandise is designated as used, in the manufacture or production of articles in the United States that are subsequently exported or destroyed.

Manufacturing drawback is primarily authorized under 19 U.S.C. § 1313(a) and § 1313(b).

The two primary methodologies are:

Direct Identification Manufacturing Drawback under 19 U.S.C. § 1313(a)
Substitution Manufacturing Drawback under 19 U.S.C. § 1313(b)

In either case, the manufactured article on which drawback is claimed generally must not be used in the United States before its qualifying exportation or destruction.

What Counts as Manufacturing or Production?

For drawback purposes, manufacturing or production is broader than simply assembling a finished product.

Under CBP regulations, manufacture or production generally means a process, including assembly, that either:

Creates a new and different article having a distinctive name, character, or use
Makes merchandise fit for a particular use, even if a new and different article is not created

Whether an operation qualifies as manufacture or production depends on what happens to the merchandise during the process.

This distinction is important because manufacturing drawback applies to qualifying manufacturing or production operations, while other activities may instead fall under unused merchandise drawback.

What Are the Two Manufacturing Drawback Methodologies?

Direct Identification Manufacturing Drawback Under 19 U.S.C. § 1313(a)

Direct Identification Manufacturing Drawback applies when imported duty-paid merchandise is actually used in a qualifying U.S. manufacturing or production process and the resulting article is later exported or destroyed.

The imported merchandise must be identifiable through the company's records. Physical segregation is not necessarily the only way to establish identification because CBP regulations permit approved inventory and accounting methods for direct identification.

Supporting records may include:

Import entry data
Commercial invoices
Inventory records
Production records
Bills of material or formulas
Manufacturing schedules
Inventory withdrawal records
Export documentation
Destruction records, when applicable

Direct identification may be appropriate when a manufacturer can establish a reliable connection between the imported merchandise, the manufacturing process, and the resulting exported or destroyed article.

Substitution Manufacturing Drawback Under 19 U.S.C. § 1313(b)

Substitution Manufacturing Drawback provides additional flexibility because the actual imported merchandise on which duties were paid does not have to be physically incorporated into the exported or destroyed article.

Instead, imported duty-paid merchandise or other merchandise generally classifiable under the same 8-digit HTSUS subheading may be used in the manufacturing process, subject to the applicable statutory requirements and exceptions.

For example, a manufacturer may import a qualifying component, place it into inventory with merchandise having the same applicable 8-digit HTSUS classification, and use qualifying substitute merchandise in production. The imported merchandise itself does not necessarily have to become part of the exported finished article.

Under § 1313(b), the qualifying merchandise generally must be used in manufacture or production within five years of the date of importation of the designated imported merchandise.

Do Substituted Materials Have to Be Commercially Interchangeable?

Generally, no.

Under the current TFTEA manufacturing drawback framework, commercial interchangeability is not the general substitution standard under 19 U.S.C. § 1313(b).

Instead, substituted merchandise generally must be classifiable under the same 8-digit HTSUS subheading as the designated imported merchandise, subject to statutory exceptions and special rules.

This distinction is important because older drawback rules and materials may refer to standards such as "same kind and quality" or commercial interchangeability that do not accurately describe the current general § 1313(b) substitution standard.

What Is the Difference Between Direct Identification and Substitution Manufacturing Drawback?

The primary difference is the relationship between the imported merchandise and the merchandise used in production.

With Direct Identification Manufacturing Drawback, the imported duty-paid merchandise itself is used in the manufacturing or production process.

With Substitution Manufacturing Drawback, qualifying substitute merchandise may be used instead. The actual imported merchandise does not have to be incorporated into the article that is eventually exported or destroyed.

Substitution can therefore provide greater operational flexibility for manufacturers that maintain common inventories of imported and domestic materials or components.

However, substitution also introduces additional classification, calculation, transfer, bill-of-material, and recordkeeping requirements.

What Are the Requirements for Substitution Manufacturing Drawback?

A substitution manufacturing drawback program must satisfy several requirements.

Depending on the transaction, these can include:

Qualifying imported duty-paid merchandise
Substitute merchandise generally classified under the same 8-digit HTSUS subheading
Use of the designated or substituted merchandise in qualifying U.S. manufacture or production
Compliance with applicable five-year requirements
Required relationships and transfers between importers, manufacturers, producers, exporters, and destroyers
A qualifying bill of materials or formula
Records supporting the manufacturing operation
Exportation or qualifying destruction of the manufactured article
Compliance with applicable drawback calculation rules
Timely filing of the drawback claim

Transfers between parties may generally be supported through business records maintained in the ordinary course of business.

Certain merchandise and transactions may be subject to specialized substitution rules, so the same 8-digit standard should not be treated as the only requirement for eligibility.

How Are Bills of Material Used in Manufacturing Drawback?

Bills of material, commonly called BOMs, help establish what merchandise is used to manufacture a finished article and in what quantities.

For substitution manufacturing drawback under § 1313(b), the statute specifically requires a bill of materials or formula identifying the relevant merchandise and article by 8-digit HTSUS subheading and identifying the quantity of merchandise used.

Manufacturing records may also be used to establish:

Components or raw materials used
Quantities consumed in production
Finished products produced
Applicable HTS classifications
Production yields
Waste or by-products
Relationship between production and exported articles

Accurate BOM and production data are particularly important when a manufacturer has numerous components, multiple finished products, changing formulations, or production across multiple facilities.

Does a Manufacturer Need a CBP Manufacturing Drawback Ruling?

A manufacturer operating a manufacturing drawback program must operate under the appropriate CBP manufacturing drawback ruling framework.

There are two primary approaches.

General Manufacturing Drawback Ruling

CBP has published general manufacturing drawback rulings covering certain common manufacturing operations.

When a manufacturer's operation fits an applicable general ruling without variation, the manufacturer may submit a letter of notification of intent to operate under the general manufacturing drawback ruling. The notification generally must be submitted concurrent with or before filing a claim, and CBP reviews it to determine whether the operation satisfies the general ruling requirements.

Specific Manufacturing Drawback Ruling

If a manufacturer's operation does not fall within an applicable general ruling, or varies from the requirements of the general ruling, the manufacturer generally must apply for a specific manufacturing drawback ruling.

The application describes information such as the manufacturing process, imported merchandise, exported articles, applicable HTSUS classifications, calculation methodology, and records used to support the claims. CBP Headquarters reviews the application and issues an approval when the proposed operation complies with drawback law and regulations.

The appropriate ruling structure should therefore be determined as part of establishing a manufacturing drawback program.

Can Manufactured Articles Be Destroyed Instead of Exported?

Yes.

Manufacturing drawback can potentially apply when a qualifying manufactured article is destroyed under CBP supervision rather than exported.

Both direct identification manufacturing drawback under § 1313(a) and substitution manufacturing drawback under § 1313(b) provide for qualifying destruction, provided the applicable requirements are satisfied and the manufactured article has not been used in the United States before destruction.

Companies considering destruction should evaluate drawback eligibility and CBP procedural requirements before the merchandise is destroyed.

How Much Can Be Recovered Through Manufacturing Drawback?

Manufacturing drawback can generally provide recovery of up to 99 percent of eligible duties, taxes, and fees, subject to the applicable calculation rules.

For substitution manufacturing drawback, the refund is generally subject to a lesser-of calculation.

For an exported article, drawback generally cannot exceed 99 percent of the lesser of:

The eligible duties, taxes, and fees paid on the designated imported merchandise
The eligible duties, taxes, and fees that would apply to the substituted merchandise if it were imported

Additional calculations apply when merchandise is destroyed or when multiple products result from a manufacturing operation.

The actual refund therefore depends on the merchandise, classifications, import values, duties and fees paid, production quantities, and applicable drawback methodology.

What Records Are Required for Manufacturing Drawback?

Manufacturing drawback programs require records capable of supporting the complete chain from importation through manufacture and eventual exportation or destruction.

Depending on the program, records may include:

Import entry information
Evidence of eligible duties, taxes, and fees paid
Commercial invoices
HTS classifications
Bills of material or formulas
Production records
Inventory records
Material withdrawal records
Manufacturing schedules
Merchandise and article transfer records
Export documentation
Destruction documentation, when applicable
Applicable general or specific manufacturing drawback ruling documentation

CBP regulations recognize ordinary-course business records as part of the documentation that can support drawback claims.

For a broader discussion, see What Documentation Is Required for a Duty Drawback Claim?

How Does J.M. Rodgers Support Manufacturing Drawback Programs?

J.M. Rodgers works with manufacturers to evaluate, establish, and manage drawback programs under 19 U.S.C. § 1313(a) and § 1313(b).

Our support may include:

Manufacturing drawback eligibility and feasibility evaluations
Direct identification and substitution methodology analysis
HTS classification analysis related to substitution
Review of bills of material and production data
Development and maintenance of manufacturing drawback rulings
Integration of import, production, inventory, and export data
Claim preparation and electronic filing
Internal claim review and compliance procedures
Claim monitoring
Assistance during CBP reviews and audits

The objective is to structure a program that identifies available recovery opportunities while maintaining the records and methodology required to support the claims.

Next Steps

If your company imports raw materials, components, subassemblies, or other merchandise used in products that are subsequently exported or destroyed, manufacturing drawback may provide a significant duty recovery opportunity.

J.M. Rodgers can evaluate your import data, manufacturing operations, bills of material, product classifications, and export activity to determine whether direct identification, substitution, or a combination of methodologies may be appropriate.

Disclaimer

This information is general in nature and does not constitute legal advice. Manufacturing drawback eligibility, ruling requirements, methodology, refund calculations, and documentation requirements depend on the specific merchandise, manufacturing operations, transactions, classifications, and applicable regulatory requirements.