The tax treatment of tariff refunds for inventory

Who receives the refund

The entity entitled to a tariff refund is the importer of record or customs broker who filed on the importer’s behalf, as these are the parties that remit tariff payments to the federal government. Importers of record and customs brokers may submit eligible refund claims through the Consolidated Administration and Processing of Entries (CAPE) system, which was established by US Customs and Border Protection (CBP) in its Automated Commercial Environment (ACE) portal. The ACE portal serves as CBP’s centralized digital system for processing import and export transactions. While it remains unclear how long CBP will take to issue refunds, the agency has said payments are expected approximately 60 to 90 days after a claim is accepted in CAPE.

In certain cases, importers of record may pass tariff costs on to third-party purchasers. Companies purchasing products from an importer of record should review their contracts and invoices to determine whether the importer is required to pass through any tariff refunds.

Tax treatment of tariffs

Understanding the tax treatment of tariff refunds requires understanding the tax treatment of tariffs. Companies that produce or purchase products for resale generally are required to capitalize tariffs, along with other direct and indirect costs, into inventory. These costs generally are recovered through cost of goods sold when the inventory is sold.

Tax treatment of tariff refunds

For a company that receives a tariff refund – either directly as an importer of record or indirectly as a purchaser of imported goods – the tax treatment of the refund depends on whether the tariff already reduced the company’s income. This largely depends on whether the related inventory has already been sold.

Inventory that has been sold

If the inventory has been sold, the tariff cost generally has been recovered through cost of goods sold. In that case, a tariff refund is includible in income because it previously produced a tax benefit. Under the tax benefit rule, a taxpayer must include recoveries of previously deducted amounts in gross income, to the extent those deductions reduced the taxpayer’s tax liability. In Hillsboro National Bank v. Commissioner, 460 U.S. 370 (1983), the Supreme Court explained that the tax benefit rule offsets the effect of a prior-year deduction when a later event (such as a recovery) is fundamentally inconsistent with that deduction. Courts have applied this principle to refunds of taxes embedded in inventory costs. For example, in Turtle Wax, Inc. v. Commissioner, 43 T.C. 460 (1965), the US Tax Court held that refunds of excise taxes previously deducted as part of inventory costs were included in taxable income.

For accrual method taxpayers, the tariff refund generally is included income when the “all events test” is satisfied (i.e., when all events have occurred that fix the company’s right to receive the refund and the amount can be determined with reasonable accuracy). Accordingly, once a company’s right to receive the refund and the amount are established, the refund may need to be included in income even if payment is not received until a later period.

Inventory on hand

If the inventory has not been sold and remains on hand at the time of refund, the tariff generally is reflected in the inventory cost, but the company has not yet realized a tax benefit from the tariff. Therefore, under Section 111 and consistent with the tax benefit rule, the company is not required to include the tariff refund in gross income. Instead, the company generally adjusts the cost of inventory for any refunds received.

A practical challenge arises in allocating tariff refunds between sold and unsold inventory. Refunds attributable to sold inventory are included in income while refunds attributable to inventory on hand generally reduce the cost of such inventory and are not included in income.

Additional tax considerations

There are, understandably, a host of additional considerations related to refunded tariffs. Multinational enterprises should consider transfer pricing implications, particularly where inventory transactions occur between related parties. Also, the federal government may pay interest on tariff overpayments, and such interest must be included in a company’s gross income and is subject to tax.

Entities that paid state sales tax on goods that included tariffs in the taxable base may also be eligible for refunds of sales tax paid on the refunded portion of the purchase price. The refund process varies by state and is complicated by the fact that sales tax generally is collected by retailers from customers and then remitted to state revenue departments. Some states require the remitting retailer to submit refund claims, with a promise to return refunded amounts to customers. Other states permit customers to file refund claims directly but require proof of tax remittance by the retailer. Most states impose time limits for filing refund claims (typically three to four years after the sale), and many also impose minimum dollar thresholds. States typically publish guidance on their refund process, and many offer an online mechanism for submitting refund claims.

Key takeaway

As companies assess their ability to obtain tariff refunds from CBP or recover amounts from suppliers, they should consider the tax implications of such refunds. If the inventory to which the tariffs relate was previously sold, the tariff refunds must be included in income. If the inventory is still on hand, the tariff refund generally reduces the cost of that inventory. Practical challenges for companies include allocating refunds across inventory pools and properly accounting for both tariff refunds and interest on tariff overpayments at the right time.