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.
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”.
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.
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 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 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.
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
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.
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
RVC — 50 percent of net cost or 60 percent of transactional value
De minimis threshold — 7 percent
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.
In 2015, Thomson Reuters in partnership with KPMG conducted a global
trade management survey. This found that around the world, 70 percent
of organizations miss out on 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.
Given all of these complexities, it makes sense that so many
companies don’t bother to leverage FTAs. However, software solutions
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.
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
MINUTE EXPLAINER: FREE TRADE AGREEMENT COMPLIANCE
TRADE AGREEMENT COMPLIANCE: CHALLENGES VS BENEFITS
THE BURDEN OF FTA COMPLIANCE