The origin of goods allows determining the customs duties applicable to each import and the value of goods when sold. It also gives access to new international markets and thus permit exporters to fully benefit from the advantages conferred by trade agreements.
Generally, any time additional work or materials are added to a product in a second or third transformation, the goods become “originating” in the producing country when a “substantial transformation” takes place. A substantial transformation will arise when the essential characteristics or properties of a product are transformed, such as when a new article with a different name, character, and use is created.
Here are the main rules of origin that companies need to know in order to take advantage of preferential trade agreements.
Changes in tariff codes
Tariff heading change rules in a trade agreement provides that non-originating inputs or products imported from outside a free trade area must undergo a specific tariff change to be considered as having originated from a particular country or region.
For example, imported raw marble or ink could both qualify as originating in the importing country, provided it’s added into another product coded under the applicable agreements in other chapters, like kitchen countertops or a printed magazine.
This kind of tariff change could also apply to any imported, semi-finished product that underwent a substantial transformation. If a mechanical appliance imported from Germany incorporates in Canada an input of any other heading – an item coded to any of the first four digits of the HS – then the origin of the imported product is deemed to be from the country where the last tariff change was made.
Ad valorem percentage rules
Under this method, the value given to a product must reach a certain minimum value percentage to be considered as originating from a particular country or region. Any additional processing done must increase the value-add to a specific level. This method of calculating value is the transaction value or net cost value of a good. The United States-Mexico-Canada Agreement (USMCA) provides that the value of the Canadian or North American content must not be less than 60% with the transaction value method or 50% with the net cost method.
When this added value is equal to or greater than a certain percentage, the goods acquire origin status from the country where the manufacturing or processing was done. Value-add is also calculated by referencing materials or components of foreign or unknown origin used in the manufacturing process. Goods maintain their origin only if the materials do not exceed a certain percentage of the value of the finished product. In practice, this method involves comparing the value of imported or originating materials with the known value of the finished product.
The value of imported components is established by the import value or purchase price. The cost of manufacturing, the ex-factory price, or the export price determines the value of exported goods.
Lists of manufacturing or processing operations
This method uses lists for each product outlining the technical and transformation processes necessary to be qualified as originating from a given country. Goods must undergo a modification beyond a simple transformation. It must include a new technique, skill, machine, tool, or device specially installed to modify a product.
Under this method, adding specific components, inputs, or a particular process is necessary to confer upon the product its origin. If you look at steel as an example, the fact it’s hot-rolled, not cold-rolled or that a particular metal, synthetic process, or coating has been applied is all part of the process to determine its country of origin.
Actions such as preserving, packing, or splitting bulk goods into smaller quantities, are also not considered in establishing the origin.
Additional rules and practices for determining the origin of goods
The de minimis Rules
There are certain circumstances where the product may be considered as originating from a specific country despite the non-originating components representing a small percentage of the finished product or do not fully comply with the required tariff change or manufacturing process. So-called de minimis rules can apply by exempting a minimum portion of non-originating materials. The de minimis threshold depends on each preferential agreement. Many preferential trade agreements allow for the de minimis rule. It almost always contains a range of exceptions and exclusions. Under the USMCA, Canada-European Union Comprehensive Economic and Trade Agreement (CETA) and the Trans-Pacific Partnership (PTP), the rule is 10% of the transaction value of the goods.
The practice of roll-up and regional value
Roll-up applies when a product that qualifies as originating under a trade agreement is used as an input in the production of a subsequent product. It allows the producer to disregard the value of any non-originating inputs used to produce that product when calculating whether the subsequent product meets a defined content threshold. In other words, if a product is manufactured in one country and meets a threshold that qualifies it as originating, its value is considered 100% originating when used in the production of another product.
Roll-up allows a Canadian producer to combine originating and non-originating components, based on a defined threshold. This allows for an intermediate product (e.g., a vehicle part) to be wholly originating in country A and sold in country B for the purpose of manufacturing a final product, which will also be wholly originating in that country.
Along the supply chain, the total value of intermediate components will thus be used successively by the trading partner countries to produce “essential” or “core” parts for certain high-value-added final products, which will be considered originating.
Trade agreements provide for certain minimum regional value content (“RVC”) thresholds to be met for those parts that are essential to the manufacture of the high value-added end-products. Vehicle manufacturers must first accurately determine the RVC of key parts (e.g., battery) and then the RVC of the finished vehicle as a whole.
Taking the example of calculating a RVC of 75% to be achieved for an electric battery. In a scenario where, for example, Canada manufactures a lithium battery for assembly in an electric vehicle, the Canadian producer will need to ensure that the imported components required to operate the battery represent less than 25% of the net cost of the battery. Under the USMCA, this “North American” battery will be duty free if exported between the three partners.
Once this threshold is crossed, the producer who assembles the battery into the electric vehicle will be able to take into account the value of the parts imported from abroad for the purpose of calculating the North American content of the vehicle as a whole. In other words, in calculating the regional value content, the value of the imported parts will reflect the cumulative value thresholds that are now understood to be originating.
DS Avocats has an experienced team of lawyers who offer a variety of advice in commercial law and customs law.
If you, your association, or your company have any questions regarding rules of origin or other trade law issues, do not hesitate to contact one of our legal advisors.