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Fundamentals of Preferential Rules of Origin. 4th Edition Module 2. Origin Determination Criteria (Part I)

Fundamentals of Preferential Rules of Origin, 4th edition.

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Author: Inter-American Development Bank (IDB) (www.iadb.org), through its Integration and Trade Sector (INT) Course coordinators: Inter-American Development Bank (IDB) (www.iadb.org), through its Integration and Trade Sector, the Institute for the Integration of Latin America and the Caribbean (www.iadb.org/en/intal/), and the Inter-American Institute for Economic and Social Development (INDES) (www.iadb.org/en/indes/). Module authors: Jeremy Harris, Specialist at the Inter-American Development Bank, Integration and Trade Sector, Lautaro RamĂrez, Consultant at the Inter-American Development Bank, Integration and Trade Sector, and Rafael Cornejo, Consultant at the Inter-American Development Bank, Integration and Trade Sector. Teaching and editing coordination: The Inter-American Institute for Economic and Social Development (INDES) (www.iadb.org/en/indes/), jointly with the Economic and Technological Development Distance Learning Centre Foundation (CEDDET) (www.ceddet.org)

4th Edition 2016

Publication property of the Inter-American Development Bank (IDB). All rights reserved. Any partial or total reproduction of this document must be reported to: BIDINDES@iadb.org The opinions expressed herein are those of the authors and do not necessarily reflect the views of the Inter-American Development Bank.

Fundamentals of Preferential Rules of Origin, 4th edition.

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Contents Contents .......................................................................................3 Introduction ...................................................................................5 Overall Objectives ..........................................................................5 Unit I. Some Features of Goods Impacting on Their Status of Origin .....6 Questions for This Unit: ...................................................................6 I.1. Categories of Products Traded Between Two Countries Party to an Agreement

...............................................................................7

I. 2. Trading of Goods and Its Impact on Their Origin Status ........... 10 Unit II. Importance of the Harmonised System When Negotiating Rules of Origin ...................................................................................... 17 Questions for This Unit: ................................................................. 17 II.1. Link Between the Harmonised System and the Rules of Origin .. 18 Unit III. How to Read and Interpret Rules of Origin ........................... 23 Questions for This Unit: ................................................................. 23 III.1. How to Read and Interpret Rules of Origin ............................ 24 III.2. Key Words for Interpreting a Rule of Origin ........................... 30 III.3. Implications of Alternative Rules of Origin ............................. 33 Unit IV. Origin Determination Criteria .............................................. 36 Questions for This Unit: ................................................................. 36 IV.1. Some Features of the Origin Determination Criteria ................ 37 IV.2. Minimal Operations Concept................................................. 41 3

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Unit V. Change in Tariff Classification .............................................. 44 Questions for This Unit: ................................................................. 44 V.1. Change in Tariff Classification ............................................... 45 V.2. Advantages of Using the Tariff Change ................................... 54 V.3. Disadvantages of the Change in Tariff Classification Criterion .... 56 V.3.1. Delays in Updating Rules of Origin ...................................... 59 V.4. Variations in the Definition of Rules Specifying a Change in Tariff Classification ............................................................................. 66 V.5. “DE MINIMIS” – Making the Change in Tariff Classification Criterion More Flexible ................................................................ 73 List of Figures .............................................................................. 79 List of Tables ............................................................................... 80

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Introduction This module describes various criteria used for establishing eligibility for preferential

treatment

under

bilateral

agreements

between

two

countries, with a view to determining and analysing the impact of origin regimes on eligible products, and the scope of application of such rules. It also starts to develop the criteria for origin determination, and tackles the change in tariff classification criterion, a substantial element of origin regimes, knowledge of which is vital for the proper operation and application of rules of origin.

Overall Objectives This module has two major objectives: â&#x20AC;˘

Firstly, to recognise the features that distinguish originating from non-originating

products,

and

the

impact

that

trading

and

transportation methods have on the origin status of goods. â&#x20AC;˘

Secondly, to conduct an in-depth analysis of the operational aspects involved in applying the change in tariff classification criterion. The analysis will particularly address the different ways of defining it, its advantages, disadvantages, flexibilities, close relationship with the Harmonised System, and the impact of this classification system on the application and control of rules of origin.

Fundamentals of Preferential Rules of Origin, 4th edition.

Unit

Some

Features

Goods

Module 2

Impacting

Their

Originating Status

This unit focuses on the distinguishing features of originating and non-originating products, and the impact of trading methods on the origin of goods, a subject of paramount importance to gain considerable insight into origin regimes.

Questions for This Unit:

•

What is the distinguishing feature of a wholly-obtained good?

•

Does the product-specific rules of origin annex to agreements apply to a wholly-obtained good?

•

Will a product manufactured in a third country but using inputs wholly produced by another country be always considered as originating from the country providing the inputs?

•

May the originating status of an input change according to the transportation or trade routes used?

•

Does the non-originating status of an input change when a good is entered into commerce in a country party to an agreement?

•

Is the originating condition of an input similar in all the agreements entered into by a country?

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I.1. Categories of Products Traded Between Two Countries Party to an Agreement The bilateral trade between two parties to an agreement is made up of various kinds of goods: originating products, non-originating products, and excluded products. Together, these products constitute the trade between these two countries. Each such product has its own features determining whether they will be subject to certain provisions of the agreement or excluded from its scope.

Figure No. 1.1. Products Included in an Agreement

Source:Prepared by the author. Originating

Products:

Trade

agreements

define

two

kinds

originating goods: those wholly obtained or produced in a member country and those that, while using an input from a third country, comply with the rules of origin negotiated in the agreement. Goods wholly obtained or produced are originating goods par excellence. They comprise all goods wholly manufactured in the territory of a country party to an agreement. These agreements specify the goods falling into this category in the form of a list, which is relatively similar in most agreements. Notwithstanding their degree of commonality, certain agreements adopt different concepts or establish different scopes regarding these products. 7

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On the whole, all goods whose production is related to nature or to the territory of a country are wholly obtained in that country. Such goods include farm products obtained in the agreement countries, products from hunting or trapping when they take place in the territory of one of the parties, and minerals and metals extracted from the territory of a party. Fishery products taken from the territorial waters or even from the high seas outside the countryâ&#x20AC;&#x2122;s territorial waters are also recognised as wholly-obtained products, although in the latter case additional conditions apply.

Depending on the

agreement, these

additional

conditions may pertain to the vessel flags, the nationality of the captain and the crew, among others. Another

type

manufactured

of from

wholly-obtained wholly-obtained

products inputs,

encompasses such

wheat

goods flour

produced out of wholly-obtained wheat in the windmill of a country party to an agreement. Finally, all goods wholly produced in the territory of the parties are wholly-obtained products, if only materials originating from one or both parties are used for their production. Figure 1.2 shows a list of products that could be considered as wholly obtained due to their production method â&#x20AC;&#x201C; provided they are manufactured in the territory of one of the parties. Once again it is worth bearing in mind that, although agreements are mostly grounded in the same concepts, there might be variations among them, since concepts are the result of a negotiation process.

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A second type of originating products is that of goods wholly or partly produced with inputs from countries outside the agreement. To qualify as originating, such products must comply with the rules of origin set forth in the agreement. In these cases, the rules determine what inputs originating outside the region may be used, and what process or transformation they must undergo to be considered an originating product once incorporated into the final good.

Figure No. 1.2. Originating Products

Source: Prepared by the author.

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I. 2. Trading of Goods and Its Impact on Their Origin Status There are some additional features to be taken into account to determine the originating status of an input or final good. Indeed, this originating status is not solely defined by production requirements but also by certain trade procedures. In other words, production conditions are a necessary but not sufficient condition because, although meeting them is essential, there are additional trade-related conditions or procedures to be observed. If an originating input is exported to another country outside the agreement and entered into commerce there, its re-exportation to a country party to the agreement loses the originating status of its original manufacture in this last transaction. This means that the originating status of a good is not permanent, since it may be lost in certain trade circumstances.

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Figure No. 1.3. Production and Trading Conditions of Originating Goods

Source: Prepared by the author. A different situation exists where there is an agreement among several parties and the originating input circulates through two or more of them. Whatever the transaction involving the input, the product will retain its originating status provided it does not leave the territory of the countries party to the agreement. Thus, if the product is nationalised in one country and re-exported to another party to the agreement, it will retain its originating status. Likewise, if an input is altered or processed in the second country, it will still be originating irrespective of the originating status of the final good. In such circumstances, the input does not lose its originating status. In other words, an originating input does not change its status by being transferred or traded in successive transactions in a given country or among countries party / member to an agreement.

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Figure No. 1.4. Circulation of an Originating Good Among Countries Party to an Agreement

Source: Prepared by the author. Let us consider another case: a non-originating input imported to an agreement country (A) and entered into commerce there. In that country, several transactions take place, one of them being the re-exportation of the input to another agreement country (B). In country (B), the input is again transferred among different operators until one of them uses it to produce a good for exportation to country (A). For the purposes of the rules of origin, this will always be a non-originating input, irrespective of any taxes paid, transactions completed, or amount of time spent in the region.

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Figure No. 1.5. Circulation of Non-Originating Inputs Between Parties to an Agreement I

Source: Prepared by the author. Therefore, a non-originating input cannot change its status by successive transfer or sale transactions in a given country or among countries party to an agreement.

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Figure No. 1.6. Circulation of a Non-Originating Input Among Countries Party to an Agreement II

Source: Prepared by the author.

Figure No. 1.7. Conditions Influencing Input Origin

Source: Prepared by the author.

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Figure No. 1.7. includes originating goods which, while produced in compliance with the requirements set forth in the origin regime, producers cannot prove as originating by means of accounting records or relevant documentation. In these cases, irrespective of actual compliance with origin requirements, the product will be considered non-originating if relevant evidence cannot be provided. In sum, a product loses its origin status if this status cannot be irrefutably demonstrated.

Figure No. 1.8. Loss of Origin Status Following Importation

Source: Prepared by the author.

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Unit Summary

In summary, this Unit entered into more detail regarding the the different circumstances in which one must be able to determine the origin of a good, both at the border and when deciding how its originating status will contribute to determining whether its use as a meterial inputs in the production of another good will affect the origin of that second good. This matters both for knowing a goods originating status, and being able to document that status for others who need that information, such as importers who will rely on that documentation and customs who will verify it.

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Unit II. Importance of the Harmonised System When Negotiating Rules of Origin

The Harmonised System (HS) is widely used by negotiators of rules of origin in order to sort out and group origin rules by product, and to define and establish the third-party inputs with which goods may be manufactured to ensure they still retain their origin status. Over 80% of the rules of origin of most agreements use the HS to specify the transformation requirements imposed on inputs from the extra-zone. This widespread use also means that subsequent updates of the HS require regular reviews and amendments because of their impact on the rules of origin.

Questions for This Unit: •

How does the Harmonised System relate to rules of origin?

•

Do the amendments to the Harmonised System lack predictability?

•

How do the various versions of the HS impact the rules of origin?

•

Do countries update rules of origin whenever a new version of the HS is introduced?

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II.1. Link Between the Harmonised System and the Rules of Origin The HS is intended to establish a standardised system of numbers and descriptions which make it possible to classify similar internationally traded goods the same way in all cuntries. The HS is structured into 97 chapters (one of which is blank for future use), each containing a different number of products, labelled headings and subheadings. The first two digits of the code represent the chapters; the headings comprise four digits (two for the chapter and two for the heading), and the subheadings include six digits (the previous four plus another two). The HS is used to negotiate different chapters of trade agreements because it facilitates identifying the goods and the scope of the several variables or concessions reciprocally granted by the parties.

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Figure No. 2.1. Applications of the Harmonised System in a Trade Agreement

Source: Prepared by the author. The HS is periodically updated by creating new subheadings, regrouping or eliminating others. These amendments are introduced approximately every four years. From the time the first version entered into force in 1992 until early 2012, the HS was updated on four occasions. On average, these changes have each amended around 10% of the subheadings, the individual impact ranging from 5.2% to 17.5% of the overall current subheadings (see Table 1).

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Certain amendments cause changes in the description, content and/or number of products in the nomenclature, whether by including new similar goods or by excluding others. In other cases, some numbers disappear because the products comprised by the subheading are moved into another one or because subheadings are merged. Likewise, new subheadings are created in order to include products previously covered by another subheading or because new products resulting

from

new

technologies

processes

require

being

individualised for trading purposes. Additionally, it is worth mentioning that the need to update the HS is not an exception, but rather a task to be performed on a regular basis. This is mainly due to: •

the technological changes impacting production processes;

•

the innovations made to the contents of inputs and goods;

•

the development of new products; and

•

the lesser importance attached to some products in international trade, which may even result in their complete elimination.

All these reasons require that the HS should be amended in order to break down existing subheadings to add new products, or to eliminate or merge others comprising goods which are no longer traded.

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Table 1. Amendments to the Harmonised System Versions

Number of subheadings Number of amended subheadings Number of chapters affected by the changes Percentage of subheadings affected by the amendment

1992

1996

2002

2007

2012

5,019

5,112

5,224

5,053

5,205

587

467

917

266

…

11.7 %

9.1 %

17.5 %

5.2 %

…

Source: Prepared by the author.

Figure No. 2.2. Reasons for Updating the Harmonised System

Source: Prepared by the author.

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Unit Summary

In summary, in this Unit we discussed the considerable impact that the HS has on origin regimes. In the majority of agreementsmore than 80% of the rules of origin use the HS to define the transformation that the inputs coming from outside the signatories must undergo. This high dependence impacts the rules when the HS is continually revised, requiring periodic revisions to update the rules.

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Unit III. How to Read and Interpret Rules of Origin

This Unit describes the techniques and mechanisms needed to interpret the rules of origin currently applied among Latin American countries and between these and the rest of the world, with the exception of the European Union. Rules of origin are worded in such a way as to require users

familiarised

with

their

components

and

with

their

interrelation and effects.

Questions for This Unit:

•

What should be taken into account when interpreting rules of origin?

•

How is their wording structured?

•

Do rules of origin contain any key words? What is their purpose?

•

What is the meaning of these key words?

•

What are the implications of alternative rules?

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III.1. How to Read and Interpret Rules of Origin There is a tacit consensus as to the wording of the current rules of origin contained in most of the agreements signed by countries in the Americas. This similar wording can be observed in almost every agreement, especially in those signed after the creation of the Latin American Integration Association (LAIA) in 1960 and the entry into force of the North American Free Trade Agreement (NAFTA) in 1994. Though more than thirty years apart, these two agreements have influenced every subsequent similar agreement. An exception is found, however, in the agreements between Latin American countries and the European Union, as well as the more recent agreements between Latin American countries and Canada, whose rules of origin define origin standards somewhat differently and are, therefore, worded differently. The tacitly accorded similarity between agreements is manifest in the sequence of the classification criteria, the language used and, even, in the meaning or interpretation assigned to certain expressions or words used in the texts.

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Figure No. 3.1. Aspects to Consider When Interpreting Rules of Origin

HOW TO READ AND INTERPRET RULES OF ORIGIN

ORDER OR PRECEDENCE OF CLASSIFICATION CRITERIA

LANGUAGE AND WORDING

KEY WORDS USED IN RULES OF ORIGIN

APPLICATION OF ALTERNATIVE RULES

Source: Prepared by the author.

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Purpose of Reading Rules of Origin Reading the rules of origin helps to understand their explicit and implicit requirements so as to implement them correctly, which is only possible if

the

reader

can

thoroughly

comprehend

their

meaning

and

implications. It is, therefore, indispensable to become acquainted with the basic strategies needed to extract information from the text, examine and organize it, to be able to apply the rules effectively at the right time. The text of the rules of origin is a coherent and cohesive unit of production requirements, sometimes made up of several components, to be interpreted as a unified whole irrespective of its extent. Rules of origin must ultimately be read by the users in certain situations, to allow them to perform specific functions. When reading the rules, it is consequently necessary to grasp their meaning correctly, for which purpose the reader must actively examine the standards and requirements.

As for the order of elements in the rules of origin, two aspects should be highlighted:

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The rule of origin consists of two parts. The first one contains the tariff Code for which the requirement is defined, and the second part is the text of the rule itself. It should be noted that, on occasions, the text does not specify the provision or the range of application of the rule. By way of example, the text may simply state that the rule is a â&#x20AC;&#x153;Change in Heading,â&#x20AC;? in a context that leaves room for ambiguous interpretations as to what goods this rule applies to or what product should meet this rule. This happens because sometimes there is a tacit agreement to omit the respective goods when drafting the origin requirements. In these cases, the good to which the rule applies is listed on the side, in another column, containing at least the tariff code number and also, in certain cases, its description. The classification criteria used are generally the same. Firstly, reference is made to the change in tariff classification required, followed by the exceptions, if any. Secondly, the value content requirement or focused value test is mentioned, with possible additional references to its specific method(s) of calculation (for instance, transaction value, net cost, build-down method, value of specified non-originating materials not to exceed a certain percentage of the value of the final goods, among others). Finally, reference is made to the required production or

processing.

These criteria may or may not be included in the rule of origin. Each rule of origin does not necessarily have to contain all of these requirements, neither is there a minimum number of criteria that must be necessarily included; in fact, the rule of origin may be based on only one of them. Other rules of origin do include in their text the product to which they apply. 27

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Table 2. Wording: Sample Text of a Rule of Origin A change to subheading 3502.11 from any other subheading, except from subheading 3502.19, provided that it has no less than 40 % of RVC and that the XX production process

Complete text of the rule. Its different parts or classification criteria are highlighted in colours

takes place in a member country

A change to subheading 3502.11

from any other subheading

except from subheading 3502.19

provided that it has no less than 40 % of RVC

Definition of the product to which the specific rule of origin applies Change

tariff

classification

requirement Exception to the change in tariff classification

Regional value content requirement

and that the XX production process Technical requirement / processing takes place in a member country

requirement

Source: Prepared by the author. The order and wording employed implicitly configure a rule of origin drafting style. In fact, this choice of words seeks to define the origin requirements in a fairly standardised manner, with economy of words and avoiding conceptual repetitions.

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Very often, the rule may be rather confusing when read for the first time or without being familiar with the implicit order or the special meaning that certain concepts in the rule are given. This is why it is fundamental to be aware of these features. Once we become familiar with this initially confusing text the wording contributes to a common, single worldwide interpretation by all agents who are involved in a trade operation and must apply a rule of origin. Additionally, there are some key words whose meaning is, on occasions, somewhat different or more specific than the most common definitions contained in standard language dictionaries, or whose connotations even go beyond the definitions included in such dictionaries. It is, then, crucial to understand these expressions and concepts thoroughly to construe a rule of origin properly. An example will help us to understand the point this paragraph seeks to make. If the expression “a change to subheading XX from any other heading” were to be interpreted literally, several doubts might arise: •

What change is being referred to?

•

What subject or product should undergo a change?

•

What are the implications in relation to the originating or non-originating status of the product undergoing the change?

•

What are the implications of failing to make that change?

•

Where are the non-permitted inputs mentioned?

•

What non-originating inputs does this rule allow?

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These are only some of the interpretations that any non-seasoned reader might come up with when reading a rule of origin. This list of doubts is not exhaustive, as other interpretations or doubts might arise.

III.2. Key Words for Interpreting a Rule of Origin For ease of interpretation of origin requirements, negotiators generally resort to a series of words or phrases that, depending on how they are used, have a more specific or broader meaning as compared to their literal interpretation. In particular, some of these words are as follows: “A change to…”: In some regimes, this expression is introduced at the beginning of each rule, with a two-fold implication or meaning: what TARIFF CODE the rule APPLIES TO and which is the final point of the change the INPUTS MUST UNDERGO; or PUT DIFFERENTLY, IT IS the tariff code applicable to the end product. (In the example, subheading 3502.11 is dried egg albumin). “From any other…”: This expression indicates the starting point of the change or shift in the tariff classification that non-originating inputs must undergo to be included in the final product for it to be regarded as originating (In the example it means that, for the products

subheading 3502.11

originating,

any

non-originating input classified in a different subheading may be used. There is no restriction as to the number or quantity of non-originating inputs, provided that they are classified in a different subheading).

Fundamentals of Preferential Rules of Origin, 4th edition.

“Except

from…”: This

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expression

indicates

that

there

restriction or limitation to the use of non-originating inputs that meet the change criteria; even when they have met this requirement, the rule

excepts

some

them

(in

the

example,

except

from

subheading 3502.19). While these inputs are compliant with the previously

defined

shift,

this

exception

forbids

the

use

non-originating inputs. In other words, inputs in subheading 3502.19 must always be originating. “Provided that…”: This expression establishes a condition whereby compliance with the origin requirements of the final product is contingent

upon

compliance

with

the

requirement

set

forth

immediately after “provided that.” This expression is actually a connector linking requirements. ”Member…”: Synonymous with partner country or party to the agreement.

SAMPLE RULE OF ORIGIN: A change to heading 37.05 through 37.06 from any heading outside the group.

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“Outside the group”: This phrase is used when the products the rule of origin refers to are defined by means of a range. In these circumstances, the expression “outside the group” means that the change requirement must always be produced from outside the group. This implies that if there are inputs meeting this tariff change requirement but their tariff classification is within the range of the tariff category, they must be necessarily originating even if they meet the established change criteria. If the rule is defined for a range and the expression “outside the group” is not included, it would allow the use of non-originating inputs that conform to the change required by the rule and that are classified within the range. In practice, the expression “outside the group” has the same impact or effect as the expression Except, as both limit or restrict the tariff change.

SAMPLE RULES OF ORIGIN: A change to heading 28.02 from any other heading; or no tariff classification change to heading 28.02 is required, if the regional content is not below: a) 50 % when the transaction value method is used, or b) 40 % when the net cost method is used.

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“Alternative rules”: If two or more rules exist for one product, the key lies in the semi-colin and the preposition “or,” which are used to end the requirements of one rule and immediately begin another form or requirement for a good to comply with the origin rule. This means

that

sometimes

negotiators

include

different

origin

compliance alternatives.

III.3. Implications of Alternative Rules of Origin This duplicity of requirements or rules of origin is aimed at enabling the manufacture of originating products through production structures with different input origin combinations. Thus, under these alternative rules, inputs required as non-originating in the first rule are often, THOUGH NOT OBLIGATORILY, allowed to be used in the second rule totally or partially. While there is no limit as to the number of rules a product may be subject to, two or three –exceptionally more– rules of origin may be set forth when compliance alternatives are desired. Another feature of alternative rules is that different classification criteria are often used to establish the requirements for each one of them. The first requirement is a given tariff change, and the second usually contains a value content or focussed value test, most often combined with a lesser change of tariff classification than that required in the first rule.

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Rules of origin should always be interpreted as requirements wholly independent from one another. This is a very significant feature, since meeting just one requirement turns the product into an originating good; the producer may freely choose which requirement to fulfil and there is no need to prove compliance with any other. Besides, there is no implied hierarchy or precedence between rules, as the producer can make the choice of its own free will.

Figure No. 3.2. Features of Alternative Rules of Origin

Source: Prepared by the author.

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Unit Summary In Summary, in this Unit we presented several substantive aspects that should be taken into consideration when reading and interpreting rules of origin, with special emphasis on the drafting and structure of the requirements, and the aspects that a practitioner should be familiar with regarding the elements of a rule, and the ways that they relate to one another, and the impacts of the variousn components. This unit serves as an introduction the the following units of this module as well as the units of the next module.

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Unit IV. Origin Determination Criteria

The criteria used in the determination of origin are some of the major elements of origin regimes; being familiar with them is essential to an adequate implementation of the origin requirements of each product. A discussion on this topic will be started in this unit and developed in the following module. Particularly, this unit will outline the various criteria used to determine origin.

Questions for This Unit:

•

What and how many criteria are there to determine origin?

•

What is the relationship between origin determination criteria and substantial transformation / sufficient production?

•

How can origin determination criteria be combined into a rule?

•

What justification is there for the minimal operations requirement?

•

What justification is there for the requirement without minimal operations?

•

What is the relationship or prevalence between origin determination criteria and minimal processes?

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IV.1. Some Features of the Origin Determination Criteria

The first chapters of the HS contain crude or little-processed raw materials, whereas in later chapters goods are more highly processed and generally require a greater amount of inputs. Hence, these raw materials and other materials deriving from their processing combine in later chapters to generate new products, which, in turn, become more sophisticated goods. According to the availability of natural and economic resources, a country will have a lesser or greater ability to produce such goods. The current economic structure, based, among other factors, on a worldwide distribution of production, results in an ever more frequent participation of inputs from many different geographic regions into the production of goods. In this way, countries entering into a trade agreement know in advance that their production structures depend on several supply sources from third countries. Sometimes, the countries party to an agreement have complementary structures and they can mutually supply the inputs required for manufacturing their goods. But this complementary relation is not sufficient; on the contrary, to a greater or lesser extent, all countries under a trade agreement need inputs from third or non-party countries for the products they export.

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This is why trade agreements should contain criteria for any third country inputs used to manufacture goods within the countries party to the agreement. As already indicated, agreements are the means by which countries grant preferences to the products they export to each other.

However,

this

not

unlimited

preference.

Mere

triangulation, that is to say, the re-exportation by a country party to an agreement to a partner country of a product previously imported from extra-zone would not justify that productâ&#x20AC;&#x2122;s access to the agreement preferences. It would also be pointless to limit preferential benefits to products wholly obtained or produced out of inputs originating from the countries party to the agreement, since it would restrict preferential trade to an extremely short list of tariff categories. If this high standard is applied, one of the basic agreement objectives, i.e., to increase trade among member countries, would be rendered meaningless. It is against this background that agreements should establish origin determination criteria to dictate to what extent a product containing third-country inputs may be considered an originating good. Determination

criteria

employ

transformation / production

different

methods

define

the

required by / on extra-regional inputs to

confer origin to the goods in which they are included. Most trade agreements use the criteria known as Change in Tariff Classification, Value Content or focussed value test, or Technical Requirement. Using one or more of these three criteria, trade agreements define the amount of extra-regional inputs that an exported product may use.

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Figure No. 4.1. Origin Determination Criteria

Source: Prepared by the author.

The purpose of these origin criteria is to guarantee the processing or change of such inputs so that they undergo what is called â&#x20AC;&#x153;Substantial Transformation"

"sufficient

productionâ&#x20AC;?.

Substantial

transformation or sufficient production is not a criterion in itself but a general concept that should somehow be measured. Therefore, origin determination criteria are subjective concepts or calculation mechanisms that measure the change taking place between extra-zone inputs and the final good traded under the agreement.

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Figure No. 4.2. Substantial Transformation or Sufficient Production

Source: Prepared by the author.

Figure No. 4.3. Use and Extent of the Origin Determination Criteria

Source: Prepared by the author. 40

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IV.2. Minimal Operations Concept Some trade agreements have introduced minimal operations into their standard setting instruments. Minimal operations encompass a number of production processes that, due to their simplicity and the scant value they contribute to the good, are regarded as not sufficiently important to confer origin to non-originating inputs. In this case, it is considered that

inputs

not

undergo

such

substantial

significant

transformationor sufficient production as to turn the resulting goods into originating products. These processes are identified during origin regime negotiations, for which reason the scope or activities of origin regimes applying this concept do not fully coincide. That notwithstanding, agreements frequently regard the production processes included in Figure 4.4 as minimal operations. It should also be borne in mind that agreements including the minimal operations concept provide that, in the event of a tariff change between non-originating inputs and the resulting good as a consequence of the minimal operation, such a change will not be sufficient to confer origin. Therefore, it is important for producers to be familiar with this concept and apply it properly, to avoid any negative implications on their products.

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Figure No. 4.4. Most Frequent Minimal Operations

Source: Prepared by the author.

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Unit Summary

In this Unit we began the discussion of the different origin qualification criteria. Knowledge of these criteria is a fundamental requirement to be able to interpret and apply the rules, and provides the context necessary to proceed to the next unit, which details the change of tariff classification criteria.

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Unit V. Change in Tariff Classification

This unit addresses the different definitions of “change in tariff classification” or “tariff change” found in trade

agreements.

Exceptions to these changes or shifts will also be analysed, together with

their

advantages

definition and

and

impact

disadvantages,

and

production their

main

structures, trade

their

facilitative

provisions, such as the “de minimis” levels. Understanding the operation of changes in tariff classification is one of the main goals of this course, in general, and of this module, in particular.

Questions for This Unit: •

What does a change in tariff classification mean? Using your own words, provide two explanations of this concept, one based on the mandatory use of originating inputs and one on their non-mandatory use.

•

What are the advantages of the change in tariff classification criterion?

•

What are the disadvantages of a tariff shift?

•

Are you acquainted with any flexibility regarding the change in tariff classification criterion? How is it applied? To what other classification criterion can this also be applied?

•

What difference is there between the number and the description of product classification and which is the prevailing concept? 44

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V.1. Change in Tariff Classification The change in tariff classification criterion is based on the various levels tariff provisions are broken down into in the nomenclature. As already explained, tariff provisions can contain two digits (chapter), four digits (heading), six digits (subheading), or eight or more digits (tariff item unilaterally implemented and applicable). This method consists in determining the shift between the classification of the non-originating inputs and of the end product manufactured with such inputs. For example, if for a given product the rule consists in changing the subheading, there is a requirement that all the non-originating inputs that may be used should be classified under any other subheading. Thus, the applicable rule of origin entails a shift between the subheading of the non-originating input and the end product containing it. Since inputs move from one position to another, instead of using the expression “tariff change” some agreements prefer to use “tariff shift,” which is used in the general regime of the Latin American Integration Association (LAIA). Nevertheless, this different denomination does not entail more than a simple terminological difference, with no practical or operational impact.

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Table 3. Sample Wording of Tariff Shift Rules LAIA 252

MERCOSUR (Chapter)

MERCOSUR (Annex)

MERCOSUR (Bolivia)

The goods produced in their territories with inputs from non-member countries, provided they result from a transformation process performed in any of the member countries, which grants them new individual features, whereby they are classified in a subheading different from the subheading of such inputs in the Latin American Integration Association Nomenclature (NALADISA).

CHAPTER III SECTIONS 3.b) and 3.c): The goods manufactured with inputs not originating in the Member Countries and undergoing a transformation process that grants them new individual features whereby they are classified under a tariff item (first four digits of the MERCOSUR Common Nomenclature (MCN)) different from that comprising the inputs.

Tariff shift plus 60 % of regional value added.

When inputs not originating in the signatory countries are used, there will be a requirement to comply with the HS change in tariff classification criterion and the regional value added criterion, whereby the maximum allowance of non-originating material amounts to 40 % of the FOB cost of the end product.

DIFFERENT EXPRESSIONS, SIMILAR IMPACTS From the point of view of production, what consequences does a tariff change rule have? WHAT IMPACTS DOES IT EXERT? The following are some of the impacts or implications of such rules: a) A tariff change rule prescribes that for a product to have originating status all of its inputs classified in the same tariff code should be originating inputs.

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b) The above requirement is tantamount to stating that for a product to be deemed originating, no non-originating inputs in the same tariff category as the end product can be used. c) Another

consequence

the

rule

lies

the

fact

that

the

non-originating inputs used to manufacture the goods must be listed in tariff headings different from those under which the end product is classified. How different? The difference is determined by the change as set out in the rule of origin; this may involve a chapter, heading, subheading or tariff item. Our example is based on a change in heading. d) The above could also be expressed as follows: the rule mandates that materials classified in any heading affected by the shift should be originating inputs. This means that the heading under which the end product is classified is divided into subheadings, so every input classified in these subheadings should be originating inputs. From the point of view of origin regimes and the application of a tariff change, these four alternatives are equivalent. They are all different expressions of the restrictions imposed on the origin of the inputs used to manufacture an end product, the only difference being that some adopt a positive standard â&#x20AC;&#x201C;what is permittedâ&#x20AC;&#x201C; while others stress what the rules prohibit (negative standard).

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Another aspect worth highlighting is that from the point of view of origin, all the transformation processes undergone by inputs should be carried out within the territories of member countries. This implies that for originating inputs to retain such status their production should result from a chain of activities performed uninterruptedly within the territory of the parties. If for any reason part of this process takes place in a third country, the end product will be considered non-originating, even if manufactured with originating inputs. Most agreements apply this concept. Nevertheless, there are some exceptions, as in the case of the agreements signed by MERCOSUR, the U.S. and Colombia with Israel, which allow the Israeli textile sector to process the fabrics in Jordan without any loss of origin status. We will delve into this issue when analysing the concept of extended accumulation.

The participation of third countries in the production process, therefore, results in the end product losing its origin status. This restriction on production

similar

even

equivalent

the

direct

trading

requirement described above. Again, these two different expressions exert the same effect.

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Figure No. 5.1. Change in Tariff Classification Cycle

Source: Prepared by the author.

For many years, tariff shift requirements were exclusively defined as described above; however, since the NAFTA entered into force, additional specifications or requirements have been added to the mere tariff shift. This innovation consisted in adopting exceptions to tariff shifts. These exceptions should be understood as restrictions limiting the use of non-originating inputs, whereby certain materials otherwise allowed by the classification change in the rule cannot use these inputs.

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Sample rule containing an exception: Change to subheading 1901.90 from any other heading, except from heading 04.02. According to this rule, the food processing classified under subheading 1901.90 may use non-originating inputs from any subheading in the tariff nomenclature, except those falling under heading 19.01 (“from any other heading”). Additionally, this rule contains the phrase “except from heading 04.02,” which extends restrictions on the use of non-originating inputs to all the inputs classified under heading 04.02 (sweetened cream and milk). These exceptions may apply to one or several chapters, headings, or subheadings, or may even be exceptions to a whole list comprising different types of categories. 1 In practice, introducing “exceptions” into

the definition of rules amounts to limiting the scope of the change, as the inputs under the provisions expressly identified as exceptions may not be used. It is worth pointing out that the introduction of exceptions to tariff shifts is not always necessary. As a matter of fact, many agreements define their own rules without setting out any exception.

A change to heading 58.01 through 58.11 from any other chapter, except from heading 51.06 through 51.13, 52.04 through 52.12, 53.07 through 53.08 or 53.10 through 53.11, or Chapter 54 through 55. 1

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Figure No. 5.2. Components of a Tariff Change Rule

WHY MAY THE VARIOUS AGREEMENTS SIGNED BY A COUNTRY CONTAIN DIFFERENT TARIFF CHANGE RULES? When comparing the rules of origin set out in the different agreements in connection with the same goods, different tariff change requirements and exceptions may be noticed. These differences are due to the input supply available in each party to these agreements. The requirement to use certain originating inputs boosts the countryâ&#x20AC;&#x2122;s production industry; this is why, in their agreements, countries encourage the use of the inputs available in their own territory by means of tariff shifts and exceptions. However, since the input supply in an agreement results from the sum of all the supplies of inputs or products of the member countries, the supply specified in any two agreements that have a country in common may differ and, in fact, it generally does.

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Let us take the case of three countries A, B and C, which have entered into bilateral agreements; A and C are non-milk producers, while B is one of the largest, most efficient producers of this commodity. It is reasonable to assume that in the rules of origin of its agreements with A and C for cheese, butter and other dairy products, B negotiates that those

manufactured

from

originating

milk.

Rules

origin

requirements are the outcome of a negotiation process that may, in certain circumstances, meet its membersâ&#x20AC;&#x2122; expectations and, in others, fall short of them. For the purpose of this example, it will be assumed that it suits the interests of A and C to accept Bâ&#x20AC;&#x2122;s request that the milk be originating, and that Bâ&#x20AC;&#x2122;s proposal is deemed reasonable and feasible by A and C and is therefore accepted. 2

It must be made clear, however, that the mere existence of supply of an input does not

necessarily entail that agreements will require that such inputs be originating. Not only must this supply be available, but it must also meet other conditions relative to quantity, quality and competitiveness. Sufficient conditions of transport and logistics must also be in place to secure efficient trade between the two countries; otherwise, trade deflection would be favoured to the detriment of consumers.

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Since there is no availability of milk in the region formed by countries A and C, at a subsequent stage during the negotiation between A and C the rules of origin will have to be designed to allow that their dairy products be made from milk sourced from anywhere in the world or, in other words, that the milk be non-originating. Given the shortage of input supply, it would be rather irrational to assume that it is possible to negotiate a rule requiring that the milk be originating, as no producer would be in a position to meet such condition for any dairy product. The preceding example aims at explaining in a simple manner the reasons why rules of origin requirements vary from one agreement to another.

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V.2. Advantages of Using the Tariff Change The change in tariff classification criterion is by far the most frequently used in all trade agreements. In many of them over 90 % of the rules are based on this criterion.

Table 4. Use of Origin Determination Criteria in the First Rule Criteria Used in Rule

LAIA

Determination

Change in Tariff Classification

MERCOSUR

Number

90.75

4877

81.5

4917

100

5224

6.11

319

Tariff Change Exception Value Content Requirement Other Requirements Total

0.04

21.83

1317

16.37

855

9.25

497

14.34

865

5.57

291

5374

6033

5224

Source: Prepared by the author. Regardless of the method or criterion used to determine origin rules, be it by a general rule and SROs, or by product-specific rules, the change in tariff classification criterion is the most prevalent.

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The pervasive use of the same criterion across agreements is an advantage, because it enables different regime users (negotiators of origin

chapters;

customs

and

trade

officials

charged

with

the

administration, control or verification of rules; customs brokers; and, above all, exporters and importers in general) to become used to a logic of reasoning, application and impact of the rules that is similar and applicable across most trade agreements negotiated among countries in all continents. For all these agreements, regardless of the disparities in the specific requirements in terms of the change levels to be applied to the inputs that each product has to use, the change in tariff classification criterion is a sort of common language or metalanguage that ensures a similar interpretation of requirements across agreement countries. Another advantage of the change in tariff classification is its simplicity. Rules of origin requirements based on the change in tariff classification criterion are relatively simple to interpret. This is so because trade operators are fairly knowledgeable of the scope and contents of the Harmonised System and its tariff classifications. Therefore, trade operators are in general well aware of what a change in tariff classification involves, and if they are not, they can easily find out. Another advantage of the change in tariff classification is that rules become easy to control and verify at the time of demonstrating the origin of a good.

Fundamentals of Preferential Rules of Origin, 4th edition.

Determining

and

locating

tariff

classifications

Module 2

â&#x20AC;&#x201C; both

for

inputs

originating from countries party to an agreement and for non-originating inputs used to manufacture a good â&#x20AC;&#x201C; and verifying them against the requirements of the rules of origin is a simple process that makes it possible to readily establish whether the good is originating or not. These origin checks may be performed with information that is easily accessible to goods manufacturers (e.g. purchase invoices and input import documents), with no need for mathematical calculations or audits of the firmâ&#x20AC;&#x2122;s accounting records. Another plus of the change in tariff classification is that it is objective. The Harmonised System (HS), on which the criterion is based, is a product classification system consisting in a logical arrangement of all tradable goods or products the composition, structure and hierarchy of which is agreed upon at world level in multilateral organisations.

V.3. Disadvantages of the Change in Tariff Classification Criterion While the HS is a useful mechanism, this classification does not necessarily meet the requirements of the rules of origin entirely. Indeed, very often the HS groups a finished product and its inputs within one same tariff heading. Placing inputs and finished products in the same tariff classification restricts the possibility of defining rules based on tariff shifts, since everything is grouped in the same provision.

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Table 5. Sample Subheadings Containing a Good and Its Parts 8452.40

Furniture, bases and covers for sewing machines and parts thereof

8607.21

Air brakes and parts thereof

8715.00

Baby carriages (including strollers) and parts thereof

8805.21

Air combat simulators and parts thereof

Source: Prepared by the author. The same can be said of the numerous so-called “basket” subheadings with a similar description (“other”), containing all similar products in the same subheading as there is no subheading that is more specific to the products. This residual nature resulting from grouping in a subheading anything not previously identified is rather arbitrary and disparate, rendering these subheadings very heterogeneous as to their scope and content. For instance, in the HS2002, out of 5224 subheadings, 840 (16 %) are “other” subheadings.

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Table 6. Sample Heading With â&#x20AC;&#x153;Basketâ&#x20AC;? Subheading HS Code 16.05

Description Crustaceans, molluscs and other aquatic invertebrates, prepared or preserved

1605.10

Crab

1605.20

Shrimps and prawns, crangon and gambas

1605.30

Lobster

1605.40

Other crustaceans

1605.90

Other

Source: Prepared by the author. Because of some of these features there is overall consensus that, though a suitable mechanism to conduct origin negotiations, the HS does not necessarily meet all the needs and production criteria discussed

origin

negotiations.

Due

this

limitation,

origin

requirements for certain products must be negotiated on the basis of other classification criteria.

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V.3.1. Delays in Updating Rules of Origin As mentioned above, the HS is updated on a regular basis, when new subheadings are added, two or more are merged into one, or subheadings

are

simply

eliminated.

Content

changes

affect

the

definitions of the rules included in these tariff headings. Indeed, changes in the scope or numbers of tariff headings may modify, neutralise or invalidate the origin requirements as agreed upon by negotiators for the products that include these provisions in their rules. The impact of these changes on annexes and rules of origin is inevitable, as all rules containing the modified tariff headings in their definition will have to be redrafted to express the same requirements previously negotiated with the newly amended tariff headings. The effort demanded is not easy to foresee as it depends on: •

the types of changes introduced in the tariff headings,

•

the number of rules using the change in tariff classification approach,

•

the number of rules linked to the tariff headings undergoing changes,

•

the frequency of use of the exceptions to the change in tariff classification, and

•

available resources.

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Regardless of the changes, to ensure proper enforcement of trade agreements and, moreover, to encourage trade facilitation measures, updating rules of origin is one of the first and most important measures to be implemented. Experience shows that updates are not performed for most trade agreements. On the contrary, most origin regimes

currently

place

and

regulating

the

most

important

preferential trade arrangements are based on two or three previous versions of the HS. Using an outdated HS version hinders the application of the change in tariff classification criterion, because it demands from operators a full mastery of equivalences between the different HS versions, which is not an easy task. In addition, it gives rise to disparate interpretations regarding the impact of changes in the rules. It is striking to note how origin regimes have been falling behind with updates. Several are the causes for these delays. Sometimes the negotiating teams lack time and resources, since they are frequently devoted to negotiating new agreements, or there may be a delay in creating and starting up the administrative commissions provided for in trade agreements. Additionally, even bureaucratic requirements may hinder the entry into force of current versions. In some cases, these requirements need Congress approval in countries party to the agreement. Undoubtedly, involving Congress or, in other words, putting the approval of a free trade agreement on the same footing as the amendment of an almost administrative instrument used for accounting record purposes, is a difficulty that results from allocating duties and responsibilities when negotiating and/or approving the agreement. These issues should be solved to facilitate trade. The rules of origin should be amended by technical and operational teams from customs 60

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and foreign ministries, and jointly put into effect by the authorities of these governmental agencies in each country party to the agreement. Failing to update origin regimes causes operators to make mistakes, results in higher complexity in preference application procedures, hinders transparency in their implementation and is, to a certain extent, conducive to corruption. For the above reasons, countries should attach more importance to this activity. Even if they cannot take these updates upon themselves, countries party to an agreement can move forward together in this area, at least unofficially, by having individual countries that are in a better position to do this publish an update on impacted rules of origin to serve as reference and facilitate operatorsâ&#x20AC;&#x2122; activities.

Figure No. 5.3. Pending Challenges in Updating Rules of Origin

Source: Prepared by the author. What sometimes gives rise to different opinions or misinterpretation among exporters and operators who try to establish equivalence between the changes in updated tariff nomenclature is determining

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whether it is the description of goods or the tariff provision number that prevails. The following comments may help to clarify this issue: •

Firstly, it should be borne in mind that the products for which a preferential treatment is sought are the main purpose of tariff negotiations.

•

The features and description of the negotiated product are used to identify the tariff classification for that product.

•

The tariff classification is always related to a certain number of digits in the Harmonised System.

•

The tariff classification numbers simply provide a system for organising and presenting items; the substantial part of any negotiation is not the number itself, but the description of the negotiated product.

The procedure to follow when establishing the equivalence between two versions of the HS is to relate the description of the negotiated product to the description of the tariff classification containing it in the new version. Once this is done, the selected description will be related to a number in the Harmonised System. These frequent equivalence-seeking processes should always prioritise descriptions over numbers.

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Figure No. 5.4. Equivalence Among the Harmonised System Versions

Source: Prepared by the author. Finally,

another

disadvantage

changes

tariff

classification

introduced into the HS is the different scope or impact that the same change or shift may have throughout the chapters. Indeed, a tariff heading change in the first chapters results in significant differences among the affected products since each heading contains very different products. An example is provided by the headings in Chapters 01 and 02, many of which relate to different animals (bovine and ovine animals, horses, etc.), or Chapter 10, where each heading covers a different cereal. However, later chapters comprise more processed and sophisticated products, so the headings show lesser differences because the entire chapter refers to a family of products. In some cases, different headings cover the same product, but they differ in product quantity, size, use, or unit strength.

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Table 7. Headings of Completely Different Products Heading 01

DESCRIPTION LIVE ANIMALS

01.01

Live horses, asses, mules and hinnies

01.02

Live bovine animals

01.03

Live swine

Source: Prepared by the author.

Table 8. Headings of Relatively Different Products (all covering the same product, and differing only in their stage of processing) Heading

DESCRIPTION

44.07

Wood sawn or chipped lengthwise, sliced or peeled, whether or not planed, sanded or finger-jointed, of a thickness exceeding 6 mm

44.08

Sheets for veneering (including those obtained by slicing laminated wood), for plywood or for similar laminated wood and other wood, sawn lengthwise, sliced or peeled, whether or not planed, sanded, spliced or end-jointed, of a thickness not exceeding 6 mm.

44.09

Wood (including strips and friezes for parquet flooring, not assembled) continuously shaped (tongues, grooved, rebated, chamfered, V-jointed, beaded, moulded, rounded or the like) along any of its edges or faces, whether or not planed, sanded or end-jointed

44.10

Particle board, oriented strand board (OSB) and similar board (for example, waferboard) of wood or other ligneous materials, whether or not agglomerated with resins or other organic binding substances.

44.11

Fibreboard of wood or other ligneous materials, whether or not bonded with resins or other organic substances

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44.12

Plywood, veneered panels and similar laminated wood

44.13

Densified wood, in blocks, plates, strips or profile shapes

44.14

Wooden frames for paintings, photographs, mirrors or similar objects

Source: Prepared by the author. Consequently, the same tariff change does not have a similar or equivalent impact throughout the nomenclature. This is something to be taken into account, as it influences production structures provided for in the rules of origin.

Figure No. 5.5. Summary of the Advantages and Disadvantages of a Change in Tariff Classification ADVANTAGES

DISADVANTAGES

• Objective.

• Harmonised System not designed for Rules of Origin:

• Simple. • Disseminated.

Others … which?

• Easier verification of origin.

HS versions

• Different requirements for the same tariff shifts

Source: Prepared by the author.

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V.4. Variations in the Definition of Rules Specifying a Change in Tariff Classification In trade agreements most rules of origin specifying a change in tariff classification are worded as explained above; however, there are variations that may render their wording more complex and, as a result, more difficult to understand. The first variation is that, when agreements specify few exceptions, the input is not defined using tariff codes but it is directly identified by its name. Supposing that the rule of origin for a certain food product in Chapter 19 includes sugar cane as a component, that the negotiators intend to impose a tariff change requirement, and that the sugar is an originating good, the rule could be drafted in two different ways: 1.

Change to subheading 1901.90 from any other subheading, except from heading 17.01. This definition is based on the use of tariff classification to define requirements.

Change to subheading 1901.90 from any other subheading, provided sugar cane is an originating good.

Again, this is an example of how the same origin requirements may be specified by using a different wording. Finally, it is worth stressing that there can be a change requirement at any classification level, but a rule of origin can only contain a single level in the definition of the change. However, exceptions to the change may include a single or multiple levels of classification; in the case of multiple exceptions, different tariff classification levels can be used. The vast majority of rules specifying a change in tariff classification are only defined using these two elements, based on the HS classifications.

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Nevertheless, a few agreements provide a small number of rules introducing variations to this method of defining a change in tariff classification criterion. A second variation, more complex in its wording, allows for the possibility of using a non-originating input whose tariff classification

included

the