Understanding the Rules of Origin for free trade agreements is complex. In the latest Precision Report we examine the differences between FTA Origin and Country of Origin.
If the popularity of ancestry DNA kits and television shows like Who Do You Think You Are? has taught us anything, it’s this: our origins can be more complicated than we might have expected.
Let’s say you were born in Chicago to an Italian-American mother and a Irish-American father, who both came from Illinois. Many Americans have similar ancestry, so that mix would make you an American through and through. But a DNA test could reveal that your family is not all from Ireland and Italy. You might have ancestors from Germany, Spain, Poland, Iceland or India too.
Goods also have complicated antecedents. Surprisingly, determining where a product is “from” can be more complex than figuring out where a person is from. After all, no matter what mix of heritage your DNA test throws up, you are still a US citizen who was born in Chicago.
So... Where Was This Made?
Raw materials and parts cross the globe every day. A clothing company in the UK might source silk from China, cotton from Egypt, fabric dye from the US and so forth. Likewise a computer manufacturer in Ireland might source motherboards from three suppliers in two different countries. These suppliers, in turn, might source raw materials from a variety of vendors across a number of countries.
Most supply chains are global. This is why it can be difficult to pin down exactly where a product is from. Imagine you have purchased a cotton shirt from the UK clothing company. Have you bought British clothes? Maybe, but not necessarily. The company could have outsourced some — or all — of the production. By the same token, the clothing company might have sourced the cotton used for your shirt from a supplier in Egypt. However, that in itself does not mean that the shirt is Egyptian cotton. The supplier in Egypt could easily have bought the cotton from China, India or the USA.
In order to make sense of this, we use “Rules of Origin”.
Rules of Origin Explained
As the name implies, Rules of Origin are rules that work out the origin of a product. Here is the World Trade Organization (WTO) definition:
“Rules of origin are the criteria needed to determine the national source of a product. Their importance is derived from the fact that duties and restrictions in several cases depend upon the source of imports. There is wide variation in the practice of governments with regard to the Rules of Origin.”
Let’s break that down a bit. First of all, the how — the “criteria needed” is the information you need to determine a product’s origin. We will discuss that in more detail later.
Next the why — a product’s origin has implications with regards to tariffs and restrictions. Therefore, two cotton shirts might be identical in every particular, except origin. Due to free trade agreement (FTA) Rules of Origin only one might qualify for reduced or zero tariffs under a particular free trade agreement.
As well as gains — such as zero tariffs — the origin of a product can mean it is restricted. Crude oil may be crude oil, but an US company cannot import it from Iran.
FTA Origin vs Country of Origin
Most people would assume that the country where goods are manufactured is the “country of origin”. That’s generally true, but it is not true under every circumstance. In fact, it is entirely possible for an automobile made in Detroit to be simultaneously American and not-American at the same time — like Schrodinger's car.
Confused? We will explain.
The difference has to do with Preferential Rules of Origin and Non-Preferential Rules of Origin.
PREFERENTIAL RULES OF ORIGIN
Preferential Rules of Origin are used to determine origin under a free trade agreement (FTA). These Rules of Origin use criteria like tariff shift, Regional Value Content, de minimis and so forth. Manufacturers can gain preferential treatment for their goods — little or no duties — if they qualify as originating under the FTA. A product that has qualified for low or zero tariffs will receive a Certificate of Origin when it originates under the FTA.
NON-PREFERENTIAL RULES OF ORIGIN
Non-preferential Rules of Origin are used to determine the Country of Origin. This is subjective. That means it is typically defined as the country where the last substantial transformation of the good took place.
As you can see, FTA Rules of Origin and Country of Origin use very different criteria. Therefore, an automobile made in Detroit, using raw materials and parts sourced from around the world, can rightly claim that its Country of Origin is the USA. However, it does not mean that the same car qualifies for preferential duties under any FTAs to which the United States is a party. As a result, you cannot use the Country of Origin to guarantee FTA Origin of a product.
Calculating FTA Origin
Government bodies issue Rules of Origin metrics. These set out how to qualify a product under a particular free trade agreement. As you can imagine, there is a wide variety in how governments around the world do this.
Having said that, the rules generally include the following criteria:
Regional Value Content
De Minimis Threshold
Tariff shift is where non-originating material inputs have been sufficiently changed through manufacturing into a new finished good.
REGIONAL VALUE CONTENT
The Regional Value Content (RVC) is where the rule requires a certain amount of materials from the signatory countries of the agreement. The RVC varies depending on the free trade agreement. Furthermore, not all Rules of Origin within a given free trade agreement require them.
De minimis is a threshold where the non-originating, non-shifting materials are so small that they are removed from the equation. Like RVC, the de minimis change depending on the free trade agreement and for some free trade agreements it is not permitted.
We have yet to see what how the Rules of Origin will change between NAFTA and the recently agreed US-Mexico-Canada Agreement (USMCA). NAFTA had 234 pages of Rules of Origin, so there's plenty of scope for change. However, using NAFTA as an example, the following figures typically apply:
Why Should You Bother?
There is a clear commercial advantage to calculating a product’s FTA origin — preferential duties. If you can sell your product in a particular market with zero tariffs, you are a more attractive trading partner.
Consider this year’s US steel and aluminum tariffs. The US government imposed tariffs of 25 percent and ten percent respectively on imported steel and aluminum. A handful of countries, including Argentina and Australia, are exempt. If you ran a brewery, you would probably prefer not to pay 10 percent duties for the aluminum needed to make beer cans. Therefore, if you can find a reliable supplier in an exempt country, it makes financial sense to do so.
The US government’s steel and aluminum tariffs were much discussed in the news. As a result, most people are aware of them. However, the WTO recognizes more than 450 FTAs. That means there are potentially hundreds of agreements that organizations could use to give themselves a competitive advantage. The surprising fact is that most don’t.
Complexities and Complications
In 2015, Thomson Reuters in partnership with KPMG conducted a global trade management survey. This found that organizations around the world miss out on 70 percent of the free trade agreements available to them.
Most organizations won’t ignore a competitive advantage for no reason. However, it is understandable why so many enterprises do not leverage FTAs. As our explanation above outlines, FTA Rules of Origin are complex. In fact, 41 percent of the organizations that Thomson Reuters/KPMG surveyed stated that this was why they did not utilize free trade agreements.
For manufacturers, FTA origin determination begins by pulling production bills of material (BOMs). They must next perform respective content calculations. If their goods qualify, manufacturers must prepare and distribute potentially thousands of FTA Certificates of Origin. Furthermore, this is a process which they may need to repeat several times during the calendar year.
It is not enough to work out a product’s FTA origin and prepare a related Certificate of Origin once. FTA origin status is not static. You will need to reassess your products if there are changes to legislation. Unfortunately, legislation can change multiple times a year. In addition, if there are changes to your costs, bill of materials or suppliers, FTA origin status can change. Even a small change to the cost of your materials can impact whether or not a finished product qualifies for an FTA.
As a result, staying compliant with free trade agreements is an onerous task. Many organizations simply don’t have the time or the personnel to do this. Plus, companies that accidentally violate the rules can be severely penalized.
Automating FTA Determination and Compliance
Given all of these complexities, it makes sense that so many companies don’t bother to leverage FTAs. However, software solutions can automate origin determination and FTA compliance. This allows you to determine the origin status of any product easily. The solution should also streamline the solicitation and creation of Certificates of Origin, and ensure ongoing compliance.
Best-in-class solutions will cover all WTO trade agreements, offer detailed origin audits and comply with record retention regulations. In addition, a comprehensive solution will allow a company to run “what if” scenarios. This will allow you to see if your organization will benefit from upcoming trade agreements.
An FTA software solution can have a significant impact on the bottom-line. A study by EY identifies FTA as the quickest payback (6 month average) and greatest ROI (500% average after 3 years) from an overall Global Trade Management (GTM) project.
About Precision Software – Trusted Global Trade and Transportation Execution
Precision Software, a division of QAD Inc., provides industry-leading global trade management, transportation execution and multi carrier shipping software solutions from a single, integrated platform. Preeminent industry leaders in every region of the world rely on Precision’s global support centers to leverage thousands of carriers and manage millions of shipping transactions every day. Our open architecture easily integrates with Enterprise Resource Planning, Warehouse Management Systems and legacy solutions. An ISO-certified company, Precision Software assists companies to minimize shipping costs, optimize first mile and last mile deliveries, automate free trade agreement compliance, avoid customs delays and mitigate the risks associated with dynamic trading environments to maximize their competitive advantage. Precision Software’s customers span multiple industries including banking and finance, life sciences, high technology, retail, industrial, automotive, higher education and public sector as well as logistics providers. For more information about Precision Software, visit www.precisionsoftware.com.
Leveraging Big Data Free Trade Agreements, Thomson Reuters
Selling the Value Of Automating Trade Compliance, Todd Smith, Ernst & Young