Rules of Origin in Canada’s New Trade Agreements Presentation to the Canadian Manufacturers and Exporters Association Mark N. SillsBrian Staples October 21, 2015

What are rules of origin (“ROO’s”)? Rules of origin are those rules used to determine the country of origin of a product for purposes of international trade Our focus today will be on preferential rules of origin PART I: DEFINITION OF ROO

Even in the area of non-preferential trade, rules of origin are often controversial Used in the fields of antidumping and countervailing duties, marking and labelling requirements for foreign products and in export controls WHERE ELSE ARE ROO’S USED?

The NAFTA introduced a full-fledged tariff shift-based regime for determining origin of goods and their consequent eligibility for NAFTA tariff preferences These rules sometimes contained supplementary rules to the tariff shift rules with regional value content (“RVC”) requirements IMPORTANCE OF ROO’S IS RELATIVELY RECENT: NAFTA

A tariff shift-based regime is on its face more precise and administratively But there are limitations and the HS itself is the product of intergovernmental government negotiations involving special interests ADVANTAGES AND DISADVANTAGES

The rules of origin in all of the above agreements reflect a series of compromises by the countries to the negotiation Rules of origin permit countries to adjust levels of access for certain sensitive sectors in their domestic economies and are preferable to product exclusions NAFTA, FTA’S, CETA AND TPP

1.Goods wholly obtained or produced in the NAFTA region 2.Goods produced in the NAFTA region wholly from originating materials 3.Goods meeting the Annex 401 origin rule (product- specific rules which are mostly “tariff shift”) 4.Unassembled goods and goods classified with their parts which do not meet the Annex 401 rule of origin but contain 60% regional value content using the transaction method (50% using the net cost method) PART II: NAFTA CHAPTER 4 DEFINES “ORIGINATING GOODS” IN 4 WAYS

Certain of Annex 401’s rules of origin contain minimum regional value content requirements in addition to tariff shifts Article 402 gives two formulas for calculating the regional value content: the transaction value method, or the net cost method. MINIMUM RVC REQUIREMENTS

The formula for calculating the regional value content using the transaction value method is: RVC = TV - VNM x 100 TV where RVC is the regional value content, expressed as a percentage; TV is the transaction value of the good adjusted to a free-on-board (F.O.B.) basis; and VNM is the value of non-originating materials used by the producer in the production of the good. TRANSACTION VALUE CALCULATION

The formula for calculating the regional value content using the net cost method is: RVC = NC - VNM x 100 NC where RVC is the regional value content, expressed as a percentage; NC is the net cost of the good; and VNM is the value of non-originating materials used by the producer in the production of the good. NET COST CALCULATIONS

The net cost method calculates the regional value content as a percentage of the net cost to produce the good The percentage content required for the net cost method (50%) is lower than the percentage content required for the transaction value method (60%) NET COST VS. TRANSACTION VALUE

The absorption or roll-up principle is a general regime-wide rule which allows the use of the entire originating status of an intermediate product when used for subsequent manufacturing operations of originating goods Intermediate materials of this nature can either be purchased from arms-length suppliers or self-produced ABSORPTION OR “ROLL-UP”

For the purpose of calculating the regional value content of final goods (using either the transaction value method or the net cost method), NAFTA Article 402(10) allows a producer to designate as an intermediate material any self-produced, originating material used in the production of the final goods. This provision covers all goods and materials except: –automotive goods defined in article 403(1) and described in Annex 403.1; and –components described in Annex 403.2, specifically engines and gearboxes INTERMEDIATE MATERIALS/SELF- PRODUCED GOODS

Tracing tracks the value of major automotive components and subassemblies imported into the NAFTA region. This significantly limits the phenomenon known as roll-up and roll-down See Annexes and TRACING

Producers of automotive goods in the US, Canada or Mexico also may elect to “average” their costs when calculating the regional value content requirement AVERAGING

To qualify for preferential treatment, textile and apparel goods must normally pass a “yarn forward” or triple transformation test This rule is significantly stricter than the US- Canada FTA rule which calls for a double transformation TPL's are available in specified cases and there are limited “short supply” provisions TEXTILES AND APPAREL

Post-NAFTA FTA agreements concluded by the US with various Latin American countries introduce new ways to calculate the value content for rules of origin Two major changes have been introduced: 1-the net cost method is now focussed largely on the automotive industry; 2- the Build up Method has been introduced. The NAFTA “transaction value” methodology has been renamed the “Build-down” Method. PART III: DEVELOPMENTS IN ROO’S SINCE NAFTA: “BUILD-UP” AND “BUILD DOWN”

RVC = ((VOM/AV) x 100) where RVC is the regional value content expressed as a percentage of the adjusted value of the good AV is the adjusted value of the good VOM is the value of originating materials acquired or self produced and used by the producer in the production of the good “BUILD-UP”

This method introduces into the formula the concept of value of originating materials separately; this means that the value content is calculated exclusively on the basis of the originating inputs BUILD-UP (CONT’D)

Similar in many respects to the “build-up” approach favoured by the US Focussed value method will benefit Canadian producers by minimizing the number of non-originating materials that must be tracked for origin purposes thereby reducing administrative burdens See example on following page “FOCUSSED VALUE” TEST APPLIED BY CANADA

A change from any other heading; or A change from subheading , whether or not there is also a change from any other heading, provided that the value of non-originating materials of subheading does not exceed 65 per cent of the transaction value of the good. (Canada – Colombia FTA) FOCUSSED VALUE EXAMPLE

Standardized value tests for kits when tariff shift is impossible (i.e. unassembled bikes) Remanufacturing: recognizing this emerging trend by recognizing “dis-assembly” as production Increased use of tariff rate quotas (TRQs) and “short- supply” mechanisms (implementation pending!!) NEW DEVELOPMENTS IN ROO’S IN CANADIAN FTA’S SINCE NAFTA

A big issue is the interface between free trade agreements that have been concluded between each of the parties and a third country or economic grouping Article 304 provides for cross cumulation. However this article requires a further administrative agreement CROSS CUMULATION

The Comprehensive Economic and Trade Agreement between Canada and the European Union (“CETA”)was signed in 2013 The text was finalized in October It is awaiting ratification by all of the EU’s 27 Member States PART IV: CETA

Canadian exporters would have had difficulties meeting stringent European rules on origin for cars, textiles, fish and certain agricultural/processed agricultural products A compromise in the form of rules of origin derogations for a limited quantity of exports (exceptions for which a more relaxed rule applies) was reached with the EU Derogations (origin quotas) for products with a higher proportion of imported inputs◦ 1.automobiles 2.◦fish/seafood 3.◦textiles and apparel 4. ◦high-sugar-containing products 5.◦chocolate and confectionery 6.◦processed foods CETA PROVISIONS ON ROO’S

The CETA allows for ROO cumulation in some specific product sectors such as autos However cumulation is only granted on a product-by- product and chapter/heading/subheading) basis; and within the CETA only CETA CUMULATION

As an example: Tariff heading (Motor vehicles) Main rule: originating goods must account for at least 50% of the ex- works or transaction value of the product Derogation however is granted for100,000 units, provided non- originating materials do not exceed 70% of the ex-works or the transaction value of the goods or 80% of the net cost Rule 1 to be modified in 7 years: non-originating materials do not exceed 45 % of the ex-works or transaction value of the product If TTIP takes place with cross-cumulation, the auto TRQ is phased out and the rule changes too so that the maximum foreign content is 40% (Mexico is not included!) CETA (CONT’D)

The Trans-Pacific Partnership (“TPP”) was signed on October 5, 2015 The TPP will include Australia, Brunei, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, United States, and Vietnam PART V: TPP

Uniform set of rules of origin that define whether a particular good is “originating” Product-specific rules of origin are attached to the text of the Agreement. Qualifying content: either a “build-down” method consistent with current Canadian free-trade agreements or “build up”/”focussed value” method The TPP provides for “accumulation” Common TPP-wide systems of certification and verification TPP PROVISIONS ON ROO’S

Auto sector ROO’s require 45 percent regional value content for finished vehicles along with a regional value content threshold between 35 and 45 percent for auto parts calculated under a net cost approach 45 percent content requirement in respect of “key Canadian- produced vehicle parts” (including engines and transmissions) and 40 percent for “other key Canadian produced vehicle auto parts.” small share of parts will only require a lower regional content of 35 percent to qualify for tariff benefits Also a “flexibility mechanism” Reportedly, “tracing” of parts will not be required under the TPP AUTOS

Not just the rules but rules administration NAFTA model – US has moved to importer certification (easier to litigate – harder for everyone else) Enforcement trends: US enhanced enforcement for textiles and apparel ( Korea, Panama, TPP…) Letting country of export undertake the risks – with consequences CERTIFICATION AND VERIFICATION

ROO’s have assumed greater importance in recent years and are no longer limited to customs compliance issues ROO’s raise important compliance issues As well, corporate strategy departments will be increasingly required to work with sourcing and compliance units Sourcing of specific components may no longer be solely a matter of technical fit and price PART VI: TRENDS FOR THE FUTURE FOR ROO’S

Since the NAFTA, the trend in ROO’s in preferential trade agreements has been to simplify NAFTA represented the high-water mark of special- interest-driven accommodation in ROO’s CETA considerably less complicated in ROO area and more flexible in terms of its quotas Remains to be seen what the TPP will bring TRENDS: CETA VS. TPP

The CETA represents a deal that is agreed and simply awaits ratification by EU member States TPP on the other hand has many more hurdles to face, including ratification by the US and Japan which is by no means certain TRENDS

Questions THANK YOU!