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As global trade tensions swirl around us, it’s a good time to highlight one of the seldom discussed features of the U.S. trade environment: duty drawbacks. Many of the tariffs charged on imported goods don’t stick; they’re subsequently refunded to the importer. This occurs through a process known as duty drawback, and Congress is poised to change how it works.
It’s tempting to describe duty drawbacks as the best kept secret in U.S. trade law, except that there’s nothing clandestine about the practice. Federal law has permitted drawbacks, in one form or another, since the late 18th century. U.S. importers have been systematically claiming tariff refunds for about as long as the United States has existed.
Recent developments have made drawbacks especially relevant. Most obvious are the tariff hikes that have occurred since President Trump took office in January. The higher any tax rate, the more important it becomes that taxpayers avail themselves of whatever relief is legally available.
The opportunity presented by duty drawbacks also limits the fiscal utility of tariffs as a major revenue source. If you still fantasize about tariff receipts financing massive income tax cuts, think again. Yes, the U.S. Customs and Border Protection (CBP) agency collects a lot of tariffs, but an impressive share of those dollars find their way straight back into importers’ pockets — up to 99 percent of the tariffs (and excise taxes) paid on relevant export sales.
Here’s a simplified synopsis of the duty drawback calculation for a hypothetical U.S. trading company:
- Annual Tariffs Paid: $10 million.
- Annual Export Sales: 20 percent.
- Eligible Tariffs: $2 million ($10 million * 0.2).
- Claimed Drawback: $1.98 million ($2 million * 0.99).
As you can see, the bottom-line tax savings are significant, and directly proportional to the firm’s export activity.
A decade ago, Congress modernized the claim process for drawbacks through the Trade Facilitation and Trade Enforcement Act of 2015 (TFTEA). Among other things, the statute required that claims be filed electronically through CBP’s online portal. The good news was that taxpayers could obtain tariff refunds in as little as 30 days under CBP’s accelerated payment program. The bad news was that oodles of documentation had to be in perfect order, or the claim would be summarily rejected. Since the enactment of TFTEA, drawback optimization has become an area of specialization for many law, accounting, and consultancy firms, and business is booming.
Critics are now asking whether drawbacks have gone too far. If the whole purpose of tariffs is to bolster domestic manufacturing by making foreign-produced goods more expensive, is the government undercutting its own trade policy by rebating up to 99 percent of the tariffs?
That’s how the trade issue melds with the One Big Beautiful Bill Act (OBBBA), the chosen vehicle for extending key provisions of the Tax Cuts and Jobs Act of 2017. The bill cleared the House of Representatives, by a single vote, on May 22. It’s now being considered by the Senate. GOP leaders remain hopeful the bill can be ready for Trump’s signature by the July 4 holiday, though several hurdles remain.
There’s buzz in Washington around how many trillions of dollars the 1,000-page OBBBA would add to the federal budget deficit, and whether it will lead to cuts in Medicaid coverage. The bill’s magnitude seems to have played a role in the disintegrating relationship between Trump and Elon Musk, who remains the world’s richest man despite seeing his net worth plunge in recent days. Musk has complained that the OBBBA will entirely negate the cost-saving efforts of the Department of Government Efficiency, in which he played a formative role.
Musk’s objections do not include the proposal to scale back drawbacks, which is scored as a modest revenue raiser ($12.1 billion over 10 years). The provision can be found at section 112032 of the bill (“Limitation on drawback of taxes paid with respect to substituted merchandise”), which primarily deals with a scenario known as the “double-drawback loophole.”
We seldom use the term “loophole” in these pages, because it’s not especially informative. The advocacy group Citizens Against Government Waste doesn’t hesitate to use it when describing the availability of double-drawbacks. Readers are encouraged to form their own conclusions as to whether the current treatment of drawbacks is overly generous.
This article provides insights on how drawbacks operate, and why a federal court invalidated previous efforts to reign in the practice. Time will tell whether the OBBBA succeeds where Treasury regulations failed.
Entries and Exits
Duty drawbacks outwardly resemble a generic export subsidy, though the details are a bit more complicated. The idea is that a reclamation mechanism should be afforded for tariffs paid on imported goods that don’t make it to market, for one reason or another. If we accept tariffs as the literal price to be paid for allowing foreign-made goods to access domestic markets, then it follows that some kind of refund ought to be granted in those instances when an imported article enters the country but never gets as far as retail shelves.
Drawbacks aren’t limited to import duties. The treatment extends to domestic excise taxes and other fees. The key to understanding the drawback is that after physical importation, something happens that causes the imported good to be unavailable for purchase by U.S. consumers. That typically occurs when the item in question is exported. As the product’s entry into the United States justifies the initial tariff, its exit justifies the drawback.
The concept can be illustrated through a set of examples.
Example 1. Manufacturing Drawback
Let’s assume the U.S. importer is a Midwestern company engaged in the production of high-end racing bicycles. It contracts with a foreign manufacturer, based in Switzerland, that produces ceramic-coated ball bearings. Over the course of a year, the U.S. company imports thousands of pounds of these bearings, paying a tariff each time a batch of them is loaded off a container ship. The bearings are used in the construction of premium wheelsets that adorn the company’s finished bicycles.
For the sake of simplification, let’s say one-third of the resulting bicycles are sold domestically, with the remaining two-thirds exported for final purchase by foreign buyers. It follows that 66.67 percent of the customs duty initially paid on the ball bearings is eligible for drawbacks, corresponding to tariffs on imported goods that eventually exit the domestic market. There is no drawback for tariffs on goods used in manufacturing that resulted in domestic sales.
This pattern is described as the “manufacturing” drawback, because the imported article functions as a commercial input. Note how the combination of importation plus domestic manufacturing is not sufficient to justify the drawback; there must be the additional element of nonavailability for domestic consumption.
Example 2. Unused Merchandise
Our second example involves slightly different facts. We have the same U.S. bicycle manufacturer that imports ball bearings from Switzerland. Here, however, the company opts to inventory one-third of its supply, choosing not to use the bearings in the production of bicycle wheelsets. Instead, it plans to sell the bearings (unprocessed) to third parties at a markup. The third-party purchasers are located overseas, meaning the Swiss-made bearings are exported after spending a few weeks in the United States as commercial inventory.
When the dust settles, one-third of the imported bearings are used in the production of bicycles sold domestically, while another one-third of the supply is used to produce bicycles that are exported. The remaining supply (the final third) is exported in an unprocessed form. Again, the result is that 66.67 percent of the tariffs paid are eligible for a duty drawback. That portion of the rebate that applies to the exported bearings is characterized as the “unused merchandise” drawback.
Substituted Merchandise
About 20 years ago, Congress expanded the use of duty drawbacks through the Miscellaneous Trade and Technical Corrections Act of 2004 (MTTCA). The law made it easier for U.S. companies to substitute one imported good for another while still claiming the drawback, provided both items shared the same code under the U.S. harmonized tariff schedule (HTS).
The practice of import substitution was common in the alcoholic beverage sector, where imports are subject to heavy excise taxes as well as tariffs. For example, a company might import 100 bottles of wine which is consumed domestically, while exporting 100 bottles of a similarly priced different wine with an identical HTS code. Through the permissive treatment of substituted merchandise, the company could claim a drawback of taxes paid on the imported wine, despite the fact it was never exported.
A subsequent law, the Food, Conservation, and Energy Act of 2008, limited duty drawbacks for wine. The substituted wines had to be of the same color variety, irrespective of HTS codes. Accordingly, a wine merchant could substitute a pinot grigio for a chardonnay and successfully claim a duty drawback for the tariffs and excise taxes paid on the import. In addition to the color requirement, the statute denied the drawback when the price variation between the two wines exceeded 50 percent.
This gave rise to an interesting opportunity — analogous to a double dip. The conventional wisdom is that it’s appropriate to allow drawbacks for substituted goods because both items would have incurred equivalent economic burdens. That reasoning is challenged when we consider the role of bonded warehouses. Normally, imports are subject to tariffs upon “entry” into the United States. An exception applies for imports immediately placed in bonded warehouses upon their arrival. If such items are subsequently exported, directly from the bonded warehouse, they avoid most U.S. tariffs and excise taxes.
Arguably, a double benefit occurs when U.S. companies export goods from bonded warehouse and then claim a drawback relating to substitute merchandise. The first benefit accrues when tariffs and excise taxes are relieved under the bonded warehouse exemption, the second benefit accrues when the drawback is granted on a substitution basis.
TFTEA had the effect of expanding the number of industries that could take advantage of double-drawbacks. Big tobacco was a natural fit, given that tobacco (like booze) is subject to significant excise taxes. At the same time, large tobacco firms were shifting much of their agricultural production outside the United States to benefit from reduced labor costs and regulatory burdens, knowing they could transport their output to U.S.-based bond warehouses and avoid both tariffs and excise taxes.
Drawbacks in Court
In the years following the enactment of TFTEA, the Treasury Department sought to close the perceived loophole. The statutory authorization for drawbacks provides as follows:
With respect to imported merchandise on which was paid any duty, tax, or fee imposed under Federal law upon entry or importation . . . that . . . notwithstanding any other provision of law, upon the exportation or destruction of such other merchandise an amount calculated pursuant to regulations prescribed by the Secretary of the Treasury under subsection (l) shall be refunded as drawback.
In principle, the double benefit illustrated above could be disallowed by an ensuing limitation, “Merchandise that is exported or destroyed to satisfy any claim for drawback shall not be the basis of any other claim for drawback.” Mindful of the apparent ambiguity in the statute, Treasury and the CBP promulgated regulations in 2018 that relied on a muscular interpretation of section 1313(v). The objective was to prevent double recoveries of tariffs and excise taxes.
The regulation made two key changes to the drawback regime. First, it altered the definition of drawback and drawback claim to include a “refund or remission of other excise taxes pursuant to other provisions of law.” Under the revised definition, the export of merchandise without payment of an excise tax counts as a claim for drawback. Second, the regulation limited drawbacks to the amount of taxes paid and not previously refunded. It was significant in that it prevented domestically produced exports from qualifying for a claim for substitution drawbacks.
For instance, under the regulations, the export of a California-produced red wine could not provide the basis for a drawback, in relation to the importation of French red wine that drew both tariffs and excise taxes. That’s because the exported California wine would have incurred no tariff or excise tax, although it would have been subject to excise taxes if it were directed towards domestic consumption. Essentially, the regulation narrowed the scope of permissible substituted merchandise for drawback purposes.
The regulations were promptly challenged in court. The National Association of Manufacturers, joined by the Beer Institute, filed a complaint before the U.S. Court of International Trade.
The plaintiffs argued that the statutory language addressing substitution drawbacks (19 U.S.C. section 1313(j)(2)), effectively blocks the government’s interpretation of the limitation provision (19 U.S.C. section 1313(v)). section 1313(j)(2) provides that the drawback shall be refunded “notwithstanding any other provision of law.”
The plaintiffs separately argued that the regulation includes a prohibition not expressly contemplated in section 1313(v) — that is, the general prohibition of a substitution drawback for excise taxes paid on imports where the substituted exports were exempt from excise tax.
In short, the plaintiffs argued the regulations were attempting to revert to the treatment of excise taxes under the pre-2004 statutory scheme, which Congress had by then rejected. The trade court ruled in the plaintiffs’ favor under a basic Chevron analysis, finding the statutory language was not ambiguous. The government appealed to the federal circuit, which upheld the trade court’s decision on the same grounds. Both courts reflected on a key piece of legislative history: On multiple occasions, CBP officials informed lawmakers of the double-drawback, yet Congress did nothing to fix it.
A Trade War on Tobacco?
As things stand today, duty drawbacks remain a vital feature of the U.S. import and export environment. The use of substitution drawbacks is common, especially in the alcohol and tobacco sectors, as authorized first by the MTTCA and later expanded on by the TFTEA. The double-drawback is alive, for now.
OBBBA, as approved by the House, would not halt the practice. Instead, it would narrow the scope of drawbacks for the tobacco industry as of mid-2026. Tobacco, of course, is among the nation’s most export-dependent agricultural sectors. A section-by-section breakdown of OBBBA released by House Ways and Means Committee Chair Jason Smith offers the following detail on the drawback provision:
Sec. 112032. Limitation on drawback of taxes paid with respect to substituted merchandise.
Current Law: Under current law, importers can claim a refund of excise taxes on imported tobacco products upon exportation of substitutable goods, even if excise tax was never paid on those substitute goods.
Provision: This provision limits the drawback of excise tax for tobacco products to scenarios in which excise tax has been paid on the exported goods that are used as the basis for the drawback claim.
Note that the House-approved provision is silent about drawbacks involving tariffs; it’s limited to excise taxes. It also says nothing about bonded warehouses or substituted merchandise. Most remarkably, it only mentions drawbacks related to tobacco products. The Joint Committee on Taxation’s revenue estimate ($12 billion) would be much higher if the provision were expanded to include excise taxes on alcoholic beverages.
Congressional Republicans are keen to pass OBBBA through reconciliation as soon as possible — and Trump is keen to sign it into law. Its enactment would represent the major legislative achievement of his second term. If it clears the Senate, it will do so over the strenuous objections of the tobacco lobby, which has come to rely on drawbacks.
Eliminating a double recovery is fine, but that’s not what OBBBA offers. One prefers that reforms be implemented as neutrally as possible. Why single out tobacco and leave other export sectors unscathed? And why not seek a more principled approach to determining what should count as substituted merchandise for drawback purposes. On the whole, the attempted regulatory fix from Trump’s first term was better tailored to solving the problem at hand.
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