Fundamentals of Preferential Rules of Origin 4th Edition Module 3. Origin Determination Criteria (Part II)
Fundamentals of Preferential Rules of Origin, 4th Edition
Module 3
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/), the Inter-American Institute for Economic and Social Development (INDES) (www.iadb.org/en/indes/), the World Customs Organization (WCO) (www.wcoomd.org), and the General Secretariat of the Central American Integration System (SG-SICA) (http://www.sica.int/) 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.
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Table of Contents Contents .......................................................................................3 Introduction ...................................................................................6 Overall Objective ............................................................................6 Unit I. Value Content Concept ..........................................................7 Objective .......................................................................................7 Questions for this Unit.....................................................................7 I.1. Value Content or Value Test Concept ........................................8 Unit II. Advantages and Disadvantages of the Regional Value Content (RVC).......................................................................................... 14 Objective ..................................................................................... 14 Questions for This Unit .................................................................. 14 II.1. RVC Advantages ................................................................. 15 II.1.1. Flexibility ...................................................................... 15 II.1.2. Avoiding the HS Restrictions ............................................ 16 II.1.3. Investment Incentive ..................................................... 17 II.2. RVC Disadvantages ............................................................. 18 II.2.1. Impact of Exchange Rate Variations ................................. 18 II.2.2. Vertical Integration ........................................................ 20 II.2.3. Wage Impact ................................................................. 21 II.2.4. Calculation, Control and Verification Requirements ............. 23
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II.2.5. Productive Inefficiencies ................................................. 24 Unit III. Formulae or Methods Most Widely Used for Calculating Value Content ....................................................................................... 26 Objective ..................................................................................... 26 Questions for This Unit .................................................................. 26 III.1. Formulae or Methods Most Widely Used for Calculating Value Content..................................................................................... 27 III.1.1. Calculation of Value Content in Integration Schemes ......... 29 III.1.2. Calculation of Value Content Under NAFTA ....................... 32 III.1.3. Post-NAFTA Formulae Devised by the US ......................... 38 Unit IV. Accounting and Allocation of the Value of Materials ............... 44 Objective ..................................................................................... 44 Questions for This Unit .................................................................. 44 IV.1. Concept and Inventory of Fungible Goods .............................. 45 IV.2 Treatment of Non-Fungible Materials ..................................... 48 Unit V. Regional Value Content. Calculation Adjustments ................... 50 Objective ..................................................................................... 50 Questions for This Unit .................................................................. 50 V.1. Introduction ........................................................................ 51 V.2. Adjustments to the Value of Materials .................................... 52 V.2.1. Adjustments to the Value of Non-Originating Materials ........ 53 V.2.2. Adjustments to the Value of Originating Materials ............... 57 V.3. Intermediate Materials or Self-Produced Materials ................... 59 4
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Unit VI. Technical Requirements ..................................................... 64 Objective ..................................................................................... 64 Questions for This Unit .................................................................. 64 VI.1. What are Technical Requirements? ....................................... 65 VI.2 Assembly and Mounting Processes ......................................... 70 VI.3 Other Ways of Defining Rules of Origin ................................... 73 List of Figures .............................................................................. 76 List of Tables ............................................................................... 77
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Introduction In order to complete the description and analysis of the various mechanisms
used
by
countries
to
implement
product
origin
requirements, other origin determination criteria, which supplement the change in tariff classification criterion reviewed in the previous module, will be addressed here.
Overall Objective As a consequence of some restrictions imposed by the change in tariff classification criterion explained in Module 2, countries employ, in their origin regimes, other origin determination criteria based on input value and production or process requirements. This module describes the main features of both criteria, their different calculation methods, and additional flexibilities for their use.
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Unit I. Value Content Concept
Objective This unit focuses on the value content or value test criterion and explains its scope, some of the various ways in which its requirements are expressed, and the differences in its application vis-à-vis the change in tariff classification criterion.
Questions for this Unit •
What are the value content components?
•
How
does
value
content
differ
from
the
change
in
tariff
classification criterion? •
What is the difference between value content and value test?
•
Why is it sometimes defined by establishing a maximum threshold and other times a minimum one?
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I.1. Value Content or Value Test Concept
This criterion, also known as value test, establishes an origin requirement mainly based on the value of the inputs that a good contains and, to a lesser extent, on the value of other production cost components, such as labour or other production and administration costs. By applying different and sometimes alternative calculation formulae, this criterion directly or indirectly determines the value of originating or non-originating inputs within the value of the good. As commented on in the previous module, the change in tariff classification criterion is mainly based on the stage of production or manufacturing of an input. This stage of input processing determines the tariff heading under which it should be classified, and the changes required in the rule are defined on the basis of this position. The value content criterion does not attach importance to the processing level of the inputs used in producing the good; instead, it focuses on the percentage of input value with respect to the value of the final good.
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Figure No. 1.1. Differences Between the Change in Tariff Classification and the Value Content Criteria
Source: Prepared by the author.
The components determining the cost of goods include basically: •
the raw materials or inputs used in their manufacture,
•
the labour required for their processing, and
•
other production, administration and trading costs, including administrative, financial and safety/security expenses, after-sales service, indirect materials, among others.
The different ways of calculating value content employ inputs as the main component.
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In addition, most calculation methods also consider, to a greater or lesser extent, the remaining cost components, or at least some of them. There are also more sophisticated calculation methods –such as the Net Cost
method–
that
exclude
some
of
these
other
production,
administration and trading costs, as will be later explained in more detail. Inputs may evidently be originating or non-originating; origin status will be a major factor in the application of value formulae. Figure No. 1.2. Components of the Cost of Goods
Source: Prepared by the author.
Some agreements identify this as the value content criterion, and other agreements as the regional value content criterion. Both concepts,
irrespective
of
semantic
distinctions,
are
essentially
interchangeable because they refer to the same requirement.
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Indeed, both notions refer to the percentage of material originating in the agreement countries and of non-originating inputs a good should contain. The reason why some countries include the word “regional� is because they wish to emphasise that this value is not calculated solely on the basis of the contribution made by the country applying the rule of origin but on the originating value contributed by all agreement countries. The origin of a product under this criterion, as under all others, is determined by the originating contributions made by all agreement countries.1 The rules of origin using the value content criterion provide that, to be regarded as originating, the production structure of a good should reach a certain numerical value. This value is expressed as a percentage of the value of the resulting good, and may be determined on the basis of the maximum number of its non-originating inputs or, failing that, by the minimum number of its originating components.
1
The way of determining the originating components of a good and the reason for requiring that originating inputs be contributed by all agreement countries, not only by the last exporting country, will be explained below when discussing accumulation.
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Figure No. 1.3. Input Content
Source: Prepared by the author.
Actually, the requirements of both methods for establishing the value content
are
equally
stringent.
For
instance,
providing
that
the
percentage of imported inputs should not exceed 40 % of the good’s value is the same as saying that the value content of the good should be no less than 60% of the good’s value. In practice, both percentages add up to 100; stating that the value content should be at least 60% presupposes that non-originating inputs may never exceed 40%, both based on the value of the good.
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Figure No. 1.4. Different Wording, Same Requirement
Source: Prepared by the author.
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Unit II. Advantages and Disadvantages of the Regional Value Content (RVC)
Objective This unit identifies and explains the advantages and disadvantages of the regional value content as an origin determination criterion vis-à-vis other criteria, and also regarding its application by operators and the control performed by the authorities. It also includes comments on how changes in certain economic variables may impact on the results of this origin determination criterion.
Questions for This Unit •
Is the RVC sensitive to the economic performance of the country where the producer resides?
•
What is its relationship to the Harmonised System?
•
What is its degree of flexibility, compared to other origin determination criteria?
•
How does the use of this criterion impact on control and proof of origin activities, by both producers and governments?
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II.1. RVC Advantages
II.1.1. Flexibility
Using the regional value content (RVC) or value content
2
criterion
has advantages and disadvantages for both producers and officials at Customs and Trade Ministries responsible for the application, negotiation or determination of the rules of origin. Impacts may differ because of the subjectivity of the criterion, since the method for meeting the value requirements set forth in the rule varies among companies according to their productive structures. Indeed, for a product to attain originating status, the regional value content criterion does not provide for the use of certain specific inputs; in fact, input selection and origin are left to the producers, who may change the origin of the same input throughout its production period by, for instance, alternating originating inputs with goods from the extra-zone. The goods will all the same be originating, provided that the value and percentage of the combination of inputs used in the final product comply with the percentages established by the rule governing such products.
2
As explained, both concepts will be used synonymously.
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This flexibility is an advantage compared to the stringency of the change in tariff classification, particularly taking into account that obtaining supplies from a number of sources makes it possible to: •
take advantage of purchasing conditions in different markets,
•
use different inputs, including different qualities,
•
make the most of any seasonal advantages in input production cycles, and
•
other conditions related to quality, quantity, and price offered by various suppliers from any country.
II.1.2. Avoiding the HS Restrictions
Not using the Tariff Classification System avoids the drawbacks of applying a product classification system some of whose headings fail to discriminate between inputs and manufactured products, or whose partidas bolsas (“other”) group a mixed, varied set of products that differ in their use and processing degree. Even if several like headings are compared, their differences are markedly apparent. In this connection, the value content criterion resolves the difficulties or avoids the disadvantages of using a product classification system such as the HS which, as already stated, was not designed in keeping with the rules of origin requirements. On the contrary, the criteria the Harmonised System is based on are more related to the type and features of the goods.
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II.1.3. Investment Incentive
Finally, a rather indirect advantage of this approach is that, under certain circumstances, the need to meet a given regional value content may lure investments associated with the production of inputs used in the production chain of the final good. The substitution of extra-zone inputs used in the production chain with raw materials produced within the territorial scope of the agreement may demand, or be accompanied by, investments. Figure No. 2.1. Advantages of the Value Content Criterion
Source: Prepared by the author.
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II.2. RVC Disadvantages
II.2.1. Impact of Exchange Rate Variations
One drawback of the value content criterion is the effect that exchange rate fluctuations may have on the structure of the production costs of a good. This macro-economic variable –beyond the producer’s control– may considerably modify the percentage of non-originating inputs in the value of a good and, on occasions, even the good’s originating status. Within a production structure, most non-originating inputs are sourced from abroad or contain a significant percentage of foreign components. This implies that all procurement operations will be, in one way or another, tied to the currency exchange. The devaluation of the local currency of the producing country brings about a disruption in the weight of non-originating inputs, as their percentage grows. When the margins of compliance with origin requirements are very tight, because the percentage of non-originating inputs is extremely close to the maximum threshold, a very abrupt or significant change in the exchange rate resulting from a devaluation may affect the originating status of a good.
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Let us take the case of good X worth 100 pesos, of which 38 are accounted for by non-originating imported inputs and, ergo, its value content is 62 pesos. The rule of origin of good X prescribes that its value content should be 60 % or above. With this cost structure, the good is originating. In this case, how would a 30 % devaluation impact upon the originating status of the good? This question may be analysed under two scenarios: A) The devaluation only affects the imported inputs. In this case, the new cost structure would be as follows:
Table 1. Cost Structure. Impact of Devaluation on Imported Inputs Baseline situation in pesos
Impact of devaluation
New cost structure in pesos
Percentage of value content
Cost of imported inputs
38
(38*30)/100= 11.4
49.4
44.3
Value content
62
62
55.7
100
111.4
Total
Source: Prepared by the author.
In this case, as a result of the variations in the impact of non-originating inputs on the cost structure brought about by the devaluation, the good no longer qualifies for originating status. B) The devaluation results in additional increases in the country’s internal costs (originating domestic inputs, labour, among others).
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Let us assume that this is a 10 % increase. In this case, this percentage will bear on the value content, as shown in the following table:
Table 2. Impact of Devaluation on All Costs Baseline situation in pesos
Impact of devaluation
New cost structure in pesos
Percentage of value content
Cost of imported inputs
38
(38*30)/100= 11,4
49,4
42,1
Value content
62
6
68
57,9
Total
100
117,4 Source: Prepared by the author.
From the table above, it can be seen that, although both the non-originating inputs and the value content have increased, the devaluation impacts on the good’s originating status. The new value content is 57.9 %, below the rule’s requirement (60 %). Hence, in this example the good is non-originating also.
II.2.2. Vertical Integration
Another disadvantage of the value content criterion is that depending on the degree of development of each agreement country, its impact may vary from one agreement party to another.
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Indeed, the greater the degree of development, the higher the chances of meeting the value content goal, as the supply of inputs in the developed country will be greater than that of its less developed partner. This is an advantage for the country with the most vertically integrated production chain, because it has more opportunities to include local inputs in its production chain. On the other hand, the situation for its partner country, which is most likely to be industrially less developed, may be disadvantageous in certain circumstances. As a matter of fact, although less developed countries can source from their partners, the cost of these raw materials or inputs may be higher there than in the partner producing country due to transportation costs. In sum, the impact of the value content on the two countries is asymmetrical.
II.2.3. Wage Impact
Another dissimilar impact of the value content across agreement countries consists in the wage gaps existing across the different agreement economies. Again, since labour costs are higher in developed countries,
their
companies
are
more
likely
to
meet
the
value
requirements compared to their competitors from other signatory countries.
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Let us take, for instance, two companies located in two different countries of the same agreement. Both use the same technology, source their inputs from the same suppliers, and –incurring the same costs– apply the same production processes and employ the same amount of labour to produce one unit of the good X. In addition, the production structure requires the same labour time, for instance, one hour in both countries. Under these assumptions, both productions are identical and have similar costs. Notwithstanding this similarity, the impact of labour upsets the parity. In the developed country, the minimum hourly wage is 8 dollars, and in the partner country, 2 dollars. This cost difference will bring about imbalances in favour of the company located in the developed country, since the value added on account of labour will be 8 dollars, while in the other one it will only amount to 2. This six-dollar gap, with the same production structure, disrupts the cost parity of both countries in favour of the company paying higher wages, even when the origin-wise contribution in terms labour, technology and inputs used is identical. This imbalance is a disadvantage of the value content calculation method; some countries have counteracted this imbalance by modifying the value content calculation formula.
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II.2.4. Calculation, Control and Verification Requirements
The value content, as opposed to other origin determination criteria, imposes additional requirements as to its application or calculation by the producer of the good and as to its control and subsequent verification. Since this is a numerical calculation based on accounting and cost information, the parties involved must keep accurate records of cost allocations and apportionments, raw material inventory file systems and, in some cases, stock lots of certain physically disaggregated inputs; a series of calculations must also be performed to apply the flexibilities and benefits provided for in the agreements in relation to the value of goods and their inputs. This additional administrative burden leads to higher costs, which are not necessarily incurred in the other origin determination criteria. Moreover, as a result of the strong emphasis placed on the use of cost information and accounting records that serve to prove the origin of a good, governments intending to verify the origin of a good after it has been imported must make arduous efforts to gather and analyse specific data about the production structure of each good. This information is obtained via requests sent to the companies being investigated. These companies are compelled to furnish the required information, otherwise their products will be regarded as non-originating and consequently lose their tariff preferences.
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It is worth noting that under this criterion, each producer voluntarily decides the combination of originating and non-originating inputs so as to meet the value requirement; for this reason, each company is a unique and distinct case. Cost structures also vary from company to company. Accounting requirements or management of inventories or suppliers sometimes require that origin verification be conducted via an on-site audit, designed to verify the data provided by the company. This audit visit results in travel costs for the importing country’s staff.
II.2.5. Productive Inefficiencies
Finally, one potential drawback of the value content criterion is that it may
cause
some
inefficiency
in
production
processes
when
a
manufacturer replaces a non-originating input purchased at competitive prices by originating raw material, which may happen to be less cost-effective or more expensive. The aim of such substitutions is to meet the value content required by the rule. In these cases, even when replacing a cheaper non-originating input by a more expensive originating one is likely to bring about economic inefficiencies, compliance with origin requirements is made easier.
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Lastly, another aspect of interest, also associated with input prices, is the control of intra-company trade operations for inputs or end products, as it is necessary to control their transfer prices. Figure No. 2.2. Disadvantages of the Value Content Criterion
Source: Prepared by the author.
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Unit III. Formulae or Methods Most Widely Used for Calculating Value Content
Objective Different integration agreements in Latin America as well as free trade agreements (FTA) among countries in the American continent lay down several product-specific rules of origin by using the regional value content criterion. This large number of agreements uses different calculation methods to determine the allowed percentages of inputs and other cost-related components of products that must originate in the agreement countries. This unit
focuses on several mathematical
calculations for determining this percentage and on the features of each of the variables employed in the formulae applied by agreements.
Questions for This Unit •
What are the distinguishing features of the value content formulae?
•
Which variables are used in each of these formulae?
•
What are the conceptual differences behind them?
•
How have regional value content calculation methods evolved in agreements with the US?
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III.1. Formulae or Methods Most Widely Used for Calculating Value Content
Before analysing the most widely used methods for calculating value content, it should be recalled that under the origin regimes of various agreements, value content may by itself determine all the origin requirements to be met by a good so that it is considered originating; it may also be combined with other criteria.
Figure No. 3.1. Possible Requirements of a Rule of Origin
Source: Prepared by the author.
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Differences in formulae depend on the following questions: • On what type of input is the calculation based? (Originating or non-originating?). • What type of value will be considered? (FOB, CIF?). • What number will be used as a denominator of the formula to express the percentage? In other words, when calculating the percentage of originating or non-originating inputs of a good, what will the value of that good be? • Will adjustments to the value of the inputs and the final good be admitted? • Within the framework of an agreement, will the percentage required by the rule be the same for all countries, or may the parties set different values among them according to, for instance, their degree of development? • Will all items in the cost structure of a good be accepted, or will the impact of some costs be limited or removed? • Will the formulae be applied on all products of an agreement using the value content criterion, or will application be determined by product type? Including some or all the alternatives above will result in a different agreement and in different formulae. This is why we need to become familiar with the most significant calculation alternatives, in order to determine their implications.
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Specifically, insofar as value content is concerned, each formula results from negotiations among countries when working on the origin chapter. There is no single selection criterion. Among the current agreements in the countries of the Americas, the most important calculation formulae are the following: a) The formulae applied by Latin American integration schemes, such
as
LAIA,
the
Community
of
Andean
Nations,
and
MERCOSUR. b) The formulae applied in the agreement among Canada, Mexico, and the United States (NAFTA). c)
The formulae applied by the United States in its agreements subsequent to NAFTA.
III.1.1. Calculation of Value Content in Integration Schemes
All economic integration agreements include the value content criterion in their origin regimes. The Latin American Integration Association (LAIA), the Southern Common Market (MERCOSUR), and the Andean Community (CAN) use origin determination criteria very similarly. As shown in the table below, all organisations calculate value content by establishing
the
maximum
percentage
of
the
CIF
value
of
non-originating inputs. The value content is calculated on the basis of the FOB value of the final good.
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Table 3. Definition of the RVC in Integration Schemes …when LAIA
the destination port CIF value or the maritime port CIF value of the materials from third countries does not exceed 50 per cent of the FOB export value of such products …
… it will suffice for the destination port CIF value or the maritime MERCOSUR port CIF value of the materials from third countries not to exceed 40% of the FOB value of the goods in question…
CAN
… provided that the process of production or transformation uses materials originating from the territory of Member Countries, and the CIF value of non-native materials does not exceed 50 per cent of the FOB export value of the products in the case of Bolivia and Ecuador... Source: Prepared by the author.
In integration schemes, it is quite frequent for Member Countries to use different percentages of value content requirements. The reason for such differences is that allowing higher percentages of non-originating inputs is one of the mechanisms to favour relatively less developed countries, whose production structures are usually more dependent on external
inputs.
Thus,
goods
manufactured
in
smaller
or
less
economically developed countries under an integration scheme can comply with origin requirements more easily. This application of regional value content requirements is a differential treatment mechanism among agreement countries; a mechanism that some integration schemes apply for the purpose of narrowing development differences among their members.
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Such is the case of the Andean Community, as may be seen in Table 3. It also occurs within MERCOSUR and LAIA, where a similar differential treatment may be observed among their member countries. Required percentages have not always remained the same; on the contrary, they have been changed. These amendments are sometimes introduced as a result of subsequent negotiations with third countries, with which more lenient requirements than those in intra-scheme trade are negotiated. This disparity in treatment between integration scheme members and extra sub-regional players has made it necessary, in some integration schemes negotiations, to grant to scheme members the most beneficial value percentages allowed in the negotiations with third countries.3
Another distinguishing feature of the rules of origin in such schemes is using the value content criterion to define an alternative rule. As may be recalled, these schemes establish a general rule, similar for all products except for those with different requirements or Specific Requirements of Origin.4 The general rule is similar, with two alternative requirements: one based on a change in tariff classification (a change of heading) and the other based on value content. This makes value content a frequently used rule within the framework of preferential trade under these schemes.
3
An example is the adjustment introduced in MERCOSUR after negotiating Economic Complementation Agreement No. 59 (ACE 59). Under this ACE, Argentina and Brazil granted Ecuador a 60 % of non-originating inputs, while the requirement for Paraguay at the time was 50 %. In order not to violate the intra-MERCOSUR benefits, the percentage allowed to Ecuador was also provided to Paraguay. 4
Under some agreements, as is the case of the Andean Community, these Specific Requirements of Origin are also known as SROs.
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The value content criterion is also used in such schemes for products resulting from assembly or mounting in some agreement country. Assembly or mounting processes are regarded as sufficiently significant to confer origin to the final good, provided they add a specific percentage of regional value content.5 III.1.2. Calculation of Value Content Under NAFTA
One of the many innovations introduced by NAFTA regarding origin is the method of calculating value content. NAFTA provides that the regional value content of a good is to be calculated on the basis of the transaction value method or the net cost method, at the choice of the exporter or producer of the good. To arrive at a formula in both methods it is necessary to previously identify all non-originating materials, add up their value, and calculate non-originating materials as a percentage of the Transaction Value of the Good (TV) or of a specifically calculated amount called Net Cost of the Good (NC). That is to say, both formulae differ in their denominator.
5
Identification of the requirement in the Certificate of Origin: (Number of the Additional Protocol to the Economic Complementation Agreement (ACE) No. 18 relating to this Decision) – CHAPTER III- SECTION 3- SUB-SECTION d); e) Products resulting from assembly or mounting operations conducted in the territory of a MERCOSUR country, using materials native to third countries, when the CIF port of destination value or CIF maritime port value of those materials does not exceed 40% of their FOB value.
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Similarly, the value content or value test will be met in both cases if the residual value of the difference between the transaction value or the net cost minus non-originating materials is, as a percentage, not lower than the percentage of the transaction value or net cost established in the rule of origin applicable to the good. I Transaction Value The following formula is used to calculate the transaction value: RVC = TV – VNM X 100 TV where: RVC is the regional value content expressed as a percentage of the transaction value of the good; TV is the transaction value of the good; and VNM is the value of non-originating materials used by the producer in the production of the good.
Transaction value is understood as the price actually paid by the producer for the good. Agreements make it possible to adjust this value in accordance with the provisions of the Customs Valuation Agreement. Non-originating inputs are all materials purchased in the agreement countries that fail to comply with the origin rule or that are purchased in third countries.
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As regards non-originating inputs used to calculate value, it should be noted that, if a producer purchases an originating material containing non-originating inputs to produce a final good, the non-originating inputs will not be taken into account to determine the regional value content of the final good. In
other
words,
non-originating
materials
incorporated
into
an
originating material are not taken into account; the entire value of the originating
material
is
considered
as
such,
irrespective
of
its
For example, the free trade agreement between Chile and Mexico states: Article 4-05: Value of Materials ‌ 4. To calculate the regional value content under Article 4-04, the value of the non-originating materials used by the producer in the production of a good shall not include the value of the non-originating materials used by: a)
another producer in the production of an originating material that is purchased and used by the producer of the good in its production;
non-originating components. Several trade agreements confer this treatment, according to which non-originating materials incorporated into originating goods or inputs are not considered when determining compliance with the rules of origin by a third good containing the originating goods or inputs.6
6
However, there are also more demanding agreements that, for the purpose of these calculations, consider that the percentage of non-originating materials included in an originating input is also non-originating (REVIEW MEXICO_BOLIVIA).
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II Net Cost The net cost method applies the following formula: RVC= NC – VNM X 100 NC RVC is the regional value content expressed as a percentage calculated on the net cost value of the good; NC is the net cost of the good, and VNM is the value of non-originating materials used by the producer in the production of the good.
Net cost is a concept specifically designed to determine the origin of a good. That determination requires gathering accounting data and making specific calculations. These accounting calculations aim at determining the value of the good more accurately, so that any cost not directly related to the production of the good is not taken into account for value determination purposes.
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Figure No. 3.2. Features of the Net Cost Method
Source: Prepared by the author.
The net cost equals the total cost of the good minus sales promotion, marketing and after-sales service costs, royalties, shipping and packing costs, and non-allowable interest costs included in the total cost of all such goods. Thus, this concept of net cost zeroes in on the costs directly related to the manufacture of the good and rules out those associated with its sale and other marketing-related activities. In terms of cost accounting, this value is relatively similar to the prime cost plus other allowable administrative and general costs. Indeed, when the costs above are deducted from the total cost of the good, the resulting value basically comprises the cost of inputs, labour, prime costs, manufacturing, and some administrative costs.
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Figure No. 3.3. Adjustments for Calculating Net Cost
Source: Prepared by the author.
While the net cost method is the most precise way of determining the value or costs allocated to a good for origin determination purposes, its calculation
demands
too
strenuous
an
accounting
effort
for
a
considerable number of companies. As a matter of fact, accounting systems in small and medium-sized businesses are not always detailed enough to determine the costs of each of the items mentioned above. Although initially the net cost method was intensively used in the NAFTA and in the regional agreements between Mexico and some Latin American countries following the NAFTA in the 1995-2000 period, its application later became restricted and today it is only applied in the rules of origin of the automotive industry. One characteristic of the automotive industry is that it is one of the industrial sectors whose end products contain the largest number of components or inputs.
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Table 4. Use of the Net Cost Method in Some Agreements7 (No. of subheadings affected by this criterion)
Agreement
NAFTA 1994
ChileCanada 1996
Chile-Mexico 1999
MexicoBolivia 1995
MexicoUruguay 2004
No. of subheadings
1.390
1.234
2.227
1.234
2.357
Agreement
Costa RicaCanada 2002
CAFTA-DR 2004 (signed)
EEUUColombia 2012
USA-Korea 2012
Mexico-Peru 2012
No. of subheadings
49
53
53
53
0
Source: Prepared by the author.
III.1.3. Post-NAFTA Formulae Devised by the US
After signing the NAFTA, the United States entered into a series of agreements with countries from Latin America and other continents. In the region, it has agreements in force with Chile, Central America, Colombia, Panama, Peru, and the Dominican Republic. The latter is a party, together with the Central American countries, to the agreement known as CAFTA-DR.
7
In the case of the CAFTA-DR, the date shown is the signature date, as it became effective on different dates in the agreement countries. The US-Peru and the US-Panama agreements apply the net cost
method to the same number of automotive subheadings as the CAFTA-DR and Colombia agreements (53).
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One of the innovations introduced in these agreements by the United States is the way of calculating the value content for rules of origin based
on
this
determination
criterion.
Two
changes
have
been
pioneered: on the one hand, the net cost method is no longer indiscriminately applied, but it is focused on the automotive industry; on the other hand, the Build-up Method, a more direct calculation method based on the percentage of originating inputs, has been introduced. Another change, more linguistic than operational, is that the NAFTA transaction method is now called the Build-down Method. Figure No. 3.4. Recent Value Content Calculation Methods in US Agreements
Source: Prepared by the author.
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Under these US agreements, when a rule of origin is based on a regional value content requirement, each party will provide that the importer, exporter or producer may calculate the regional value content based on the following methods: (a) Method Based on the Value of Non-Originating Materials (Build-down Method) RVC = (AV – VNM)/AV x 100 where: RVC is the regional value content expressed as a percentage of the adjusted value of the good; AV is the adjusted value of the good; VNM is the value of non-originating materials acquired and used by the producer in the production of the good.
(b) Method Based on the Value of Non-Originating Materials (Build-up Method) RVC = ((VOM/AV) x 100) where: RVC is the regional value content expressed as a percentage of the adjusted value of the good; AV is the adjusted value of the good; VOM is the value of originating materials acquired or self-produced and used by the producer in the production of the good.
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c) Calculation Method for Automotive Goods (Net Cost Method) RVC = (NC – VNM) / NC x 100 where: RVC is the regional value content expressed as a percentage of the adjusted value of the good; AV is the adjusted value of the good; VNM is the value of non-originating materials acquired and used by the producer in the production of the good.
As already stated, not all these alternative calculation methods are applied for each of the products the rules of origin of which are value content-based, as they can be included on a separate or combined basis. Since both the build-down method –which, as mentioned above, is similar to the transaction value method– and the net cost method apply the same calculation formula as that established in the NAFTA, it will not be necessary to provide any further explanation. On the other hand, the build-up method, or method based on the value of originating materials, represents a major breakthrough in US agreements as far as value calculation is concerned.
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Indeed, this method introduces in the formula the concept of value of originating materials separately; this entails that the value content is calculated exclusively on the basis of the originating inputs. Thus, the formula establishes a minimum percentage or threshold these inputs must represent in the total cost of the good. The advantage of this formula is that it is only based on the percentage of inputs excluding labour costs. As mentioned before,8 one of the drawbacks of value content is the dissimilar impact exerted as a result of the disparate wage levels existing in the different agreement countries. This method –solely based on originating inputs– offsets such differences. The different elements or concepts composing each formula also result in different percentage requirements of the value content used for calculations. On the whole, the build-up method requires a lower percentage than the build-down method. The reason for this is that in the build-up method the percentage can only be obtained from originating inputs, while under the build-down method, value represents labour, inputs, and other originating costs.9 It is customary for both the build-up and build-down methods to be alternatively applied for a given tariff item. The operator can opt for either of them and there is no predetermined order of preference; its selection may be based, among other reasons, on ease of compliance and demonstration.
8
See Unit II, II.2. RVC Disadvantages, and II.2.3. Wage Impact. It should be borne in mind that regional value content is the difference between the value of the good and the value of non-originating inputs. Therefore, the resulting difference implicitly contains the cost of labour, inputs, and other originating costs. 9
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Figure No. 3.5. Build-up Method
Source: Prepared by the author.
Again, the explanation of the net cost and build-down methods is not included, as they were discussed in the previous section.
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Unit IV. Accounting and Allocation of the Value of Materials
Objective The individual value of the materials incorporated into a product is essential to calculate value content. This unit focuses on the recording and calculation treatment applied to the purchase of materials, and the concept of fungible goods.
Questions for This Unit •
What are fungible goods or materials?
•
What is the purpose of applying generally accepted accounting principles?
•
What is the difference in treatment between fungible goods and other goods that can be kept in independent stocks?
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IV.1. Concept and Inventory of Fungible Goods
In the ordinary course of business, the purchase of materials is not a single transaction. For economic, financial, and even physical reasons, inputs used to manufacture goods are obtained as a result of repeated purchase transactions or orders. In general, there is what is known as a minimum stock of each material, meaning the quantity of material that must always be available; shortly before the minimum stock is reached, new purchases are usually made for restocking purposes. Therefore, in any given time period or accounting year there may be many purchases of a certain input for the same or a different price. In the event of transactions with different unit prices, two aspects must be considered: i) how materials are stored; and ii) as there are several unit prices, what cost is to be taken into account to determine regional value content. Storage will depend on the type of input. In some cases, purchases may be stored separately; separating each purchase physically will permit a clear identification of the batch being used. Storing each purchase batch separately makes it easy to clearly and immediately identify the cost or purchase price of input units, their country of origin, and whether such units are originating. However, keeping each purchase of materials separate from each other is not free of difficulties and it increases costs. The first difficulty is the need to have enough room to keep each purchase order or batch separate from the rest. This separation also entails more costs in terms of moving, recording, and monitoring each purchase order.
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There is a type of materials which has specific characteristics due to unit features and their similarity. These products are identified by origin regimes as fungible materials. Fungible Goods or Materials are those that are interchangeable for commercial purposes and whose properties are essentially identical. If materials or finished products meet such conditions, origin regimes authorise their joint stocking or storage. It is not required to keep these materials segregated; they may be in the same hopper, warehouse, or storage yard. It is possible to stock and commingle units of different origin, purchased from different suppliers, under different purchase orders, at different prices. When different purchases of the same material or finished good are commingled in a single stock and inventory the following questions arise: i) how can it be determined that the units used from this single stock to produce a final good are originating or non-originating?; and ii) since there were different purchase prices, what value should be used to calculate the regional value content? NAFTA Article 406 “Fungible Goods and Materials� may be taken as an example of the way in which agreements allowing the use of this type of materials generally solve this difficulty..
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Article 406. Fungible Goods and Materials For purposes of determining whether a good is an originating good: a.
a) where originating and non-originating fungible materials are used in the production of a good, the determination of whether the materials are originating need not be made through the identification of any specific fungible material, but may be determined on the basis of any of the inventory management methods set out in the Uniform Regulations; and
b.
b) where originating and non-originating fungible goods are commingled and exported in the same form, the determination may be made on the basis of any of the inventory management methods set out in the Uniform Regulations.
It should be clarified that “the inventory management methods established in the Uniform Regulations� of NAFTA are the Generally Accepted Accounting Principles adopted by the parties to the agreement, also used in the remaining agreements. Although the Accounting Principles are country-specific, there is quite a broad consensus on three inventory accounting methods, which are applied by almost all countries using these principles. The three methods are the following: a) LIFO (Last In-First Out). b) FIFO (First In-First Out). c)
Weighted Average Price.
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Figure No. 4.1. Management of Fungible Materials
Source: Prepared by the author.
IV.2 Treatment of Non-Fungible Materials
Other goods or materials, due to their features, volume, and/or price, may be kept separately in physical stocks, whether as unit goods or by purchase batch. Let us imagine, for instance, that coils of yarn are purchased. Because of their size, these products are not mixed but remain physically separated from one another. The same could apply to shipments or batches of electric motors used to manufacture white goods. In these cases, when using these inputs, it is possible to identify the shipment or purchase order under which they were bought. Since the purchase order can be identified, the purchase price of the goods may be ascertained. 48
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In this context, having •
each purchase unit or batch physically separated, and
•
accounting documents that allow ascertaining the purchase price of each good,
makes it possible to determine the actual cost of the materials used within the manufacturing cost of a product. In this way, it is not necessary to use the inventory accounting principles since it is possible to directly find out and allocate the actual cost incurred when purchasing each unit for a specific production activity. Figure No. 4.2. Allocation of the Non-Fungible Materials Cost
Source: Prepared by the author.
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Unit V. Regional Value Content. Calculation Adjustments
Objective This unit addresses the treatment of some facilities that may be applied when determining a good’s compliance with rules of origin requirements. The first such facility is a number of adjustments to the value of both originating and non-originating materials, with a view to calculating the exact quantity and value of originating and non-originating components used in a good. Another facility is provided by intermediate or self-produced materials. Actually, this type of material is used as an accounting
adjustment
that
puts
production
processes
vertically
integrated in a single producer on an equal footing with the same processes which are subdivided and completed by several producers.
Questions for This Unit •
What is the purpose of the facilities analysed in this unit?
•
To what type of materials is each such facility applied?
•
Are both facilities solely applied by rules of origin using the value content criterion?
•
How and when is each such facility applied?
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V.1. Introduction
Several agreements entered into by the United States, Mexico, Canada, and MERCOSUR, among others, include two flexibility provisions in their chapters on rules of origin. One of them is designed to facilitate the application of and compliance with value requirements; the other is aimed at placing products manufactured by companies with integrated production processes on an equal footing with goods resulting from production processes that are divided or shared among different companies. Such facilities are i) the permitted adjustments to the value of materials, and ii) the intermediate materials, also referred to as self-produced materials in some agreements.
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V.2. Adjustments to the Value of Materials
Materials are defined as goods used in the production of another good, including parts or ingredients. According to this definition, materials encompass all the inputs needed to produce a good. From the origin standpoint, inputs may be originating or non-originating, according to the level of compliance with their respective rules of origin. In terms of a company’s production costs, the value of a material is generally made up of the purchase price paid to the manufacturer or seller, plus transportation, taxes, and all other costs incurred until such materials are placed in the company’s warehouse. In the case of imports, the cost of materials also includes import duties or taxes, insurance, and other Customs clearance and importation expenses. Therefore, cost is composed of various items, and it is necessary to conduct a step-by-step analysis of their calculation or impact on the value of the materials subsequently used to determine the regional value content. Concerning imported materials, the agreements establish that their value will result from application of the provisions of Articles 1 through 8, Article 15, and the relevant interpretative notes of the Customs Valuation Agreement. In these articles, the Valuation Agreement sets forth several criteria for determining the value of a good, depending on whether a precise transaction or purchase price is available.
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V.2.1. Adjustments to the Value of Non-Originating Materials
In this case, the adjustment consists in subtracting a number of expenses and costs if included in the value of non-originating materials. As already mentioned, the ex-works price of a good includes all costs and expenses incurred when purchasing and transporting materials. However, some of these expenses may have taken place in the territory of a member country, or taxes may have been paid in that same country, or transportation may have been performed by domestic companies. Even if these activities are included in the value of the non-originating materials thus making them more expensive, they all represent “originating” costs or expenses, since they have been incurred by service suppliers from the agreement country. That is the case, for instance, of transportation or insurance costs contracted from, and supplied by, domestic companies. This argument may be justified by reduction to absurdity. If subtracting these costs from the value of the non-originating material were not allowed, the determination of origin of the good that contains it would “punish” the producer, since part of the locally provided services would be regarded as non-originating. It should be noted that the same treatment must be afforded to originating materials that may be included in non-originating goods.
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Figure No. 5.1. Costs Considered in Non-Originating Materials
Source: Prepared by the author.
Another element used to adjust the value of a non-originating material downward is the waste occurring when the non-originating material is used to manufacture the good that incorporates it. That waste, which may for example be the scraps resulting from cutting wood, is treated as rubbish; it is not taken into account for determining the value of the non-originating material and, therefore, its pro rata cost must be subtracted from the value of the non-originating material. In other words, if the cost of a non-originating table is 200, and the waste generated during the final production process amounts to 20% of the table –40 as expressed in value terms– the value of the non-originating material to be used for calculating value content will be 160 (200 – 40 = 160).
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However, in the event that the waste has a commercial value and may be sold as a by-product, the sale proceeds may not be subtracted from the cost of the non-originating material. In the previous example, if the sale proceeds of the by-product amount to 30, there will be a lesser adjustment, as shown by the following calculation: {200 – (40-30)= 190}. What is the impact of all the above adjustments on the percentage or weight of non-originating materials used for calculating value content? Subtracting
such
costs
and
expenses
from
the
value
of
the
non-originating material will reduce the percentage or weight of that material on the value of the product and, accordingly, the relative share of the material. Consequently, these adjustments aim at facilitating compliance with the rules of origin requirements.
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Figure No. 5.2. Adjustments to Non-originating Materials
Source: Prepared by the author.
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V.2.2. Adjustments to the Value of Originating Materials
The value of originating materials can also be adjusted. Any cost incurred concerning the purchase, transportation, and shipping of the input not included in its value may be added to it. In this case, these additional costs are reckoned and, therefore, the impact of materials will be greater after the adjustment. The difference between adding and subtracting the new expenses and costs
is
not
adjustments
the to
only
the
inequality
originating
existing
and
when
calculating
non-originating
inputs.
the The
treatment of waste is also dissimilar. In the case of originating inputs, waste is not accounted for. Hence, the value of originating materials will not undergo any adjustment or change on account of the existence of waste; its cost will not be deducted from or added to the cost of the input.
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Figure No. 5.3. Adjustment to Originating Materials
Source: Prepared by the author.
In sum, adjustments to the value of both originating and non-originating inputs
help
to
meet
the
value
content
requirements,
because
adjustments increase the value of originating inputs and reduce the value of non-originating ones.
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Figure No. 5.4. Impact of Adjustments
Source: Prepared by the author.
V.3. Intermediate Materials or Self-Produced Materials10
Both concepts are synonymous and used interchangeably with the same meaning in several agreements. Both refer to originating materials produced by the manufacturer, who later uses them to produce another good within the same production process.
10
Interestingly enough, these materials lend flexibility to the tariff classification criterion and may also be applied, in the manner described here, to a rule based on a change in tariff classification. However, they have been included within the discussion of value content, because they are easier to explain within this framework as their impact is more clearly and directly seen in this requirement.
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Figure No. 5.5. Concept of Self-Produced or Intermediate Materials
Source: Prepared by the author.
Origin regimes establish a special treatment for this type of goods to ensure that rules of origin are applied as impartially as possible and that their impacts are as egalitarian as possible across the different operators of agreement countries. Let us assume the case of an integrated manufacturer of refrigerators “A”; these refrigerators are entirely produced by such manufacturer, i.e., it makes the metal sheet of the appliance, and the production process includes the manufacture and assembly of the motor. Let us also assume that the rule of origin applied to this product is value content-based. To make the engine, this manufacturer has to purchase several inputs, some originating –purchased in the local market– and some non-originating –imported. To determine compliance with the rule of origin applicable to the refrigerator, manufacturer A will have to consider all the non-originating inputs used to manufacture it, including
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Fundamentals of Preferential Rules of Origin, 4th Edition
the
non-originating
materials
employed
Module 3
when
manufacturing
and
assembling the motor. In other words, the non-originating inputs of the motor bear on the origin determination of the refrigerator. Let us compare this case against that of a non-integrated producer “B”, which purchases the motor from supplier “C”. This supplier C, which is independent from B, uses the same originating and non-originating inputs as manufacturer A. Supplier C manufactures the motor and, given the composition of the inputs used, meets the rule of origin. Consequently, when C sells the motor to B, it sells it as originating. In determining whether the refrigerator is originating or non-originating, producer B will regard the entire motor as originating. From the last two paragraphs it appears that A and B do not stand on an equal footing when they have to comply with the rule of origin. While non-integrated producer B considers 100% of the value of the motor to be originating when it applies the refrigerator’s rule of origin, integrated producer A must include the non-originating inputs of the motor and consider them as such in the calculation of the refrigerator’s rule. Then, the latter is at a disadvantage even when both motors are identical. Consequently, there are disparities between both producers in terms of origin requirements, simply because one bought the motor input (B) while the other one manufactured it (A). This unfair dissimilar treatment is counteracted by allowing the integrated producer to subdivide its production process and create, during the course of the production process, an intermediate good, for example the motor. As a result of this subdivision, it obtains an originating input (motor) and considers
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100 % of its value as such at the time of applying the rules of origin of its end product (refrigerator). How
does
the
integrated
producer
determine
the
value
of
an
intermediate material? In general, the agreements that adopt this concept
coincide
in
recognising
as
value
components
of
these
intermediate materials all material and labour costs incurred to manufacture them, a share of the general expenses and a reasonable percentage of profit equivalent to the profit obtained in the normal course of trade. Figure No. 5.6. Determination of the Value of an Intermediate Material
Source: Prepared by the author.
There are some discrepancies across agreements in the way of applying the intermediate material facility or mechanism. The most salient ones include the following: •
Some agreements restrict this facility by establishing that only one intermediate material may be used in a good’s production process; others impose no quantity limitation. 62
Fundamentals of Preferential Rules of Origin, 4th Edition
•
Module 3
Under some agreements, intermediate products must always be originating.
•
Under other agreements, it is possible to use as intermediate material both originating and non-originating inputs, and the producer may choose which best suits its needs at the time of meeting the rules of origin.
Again, this concept is discussed in this unit dealing with the value content criterion. It has been included in this unit because it is easier to explain how it works using value content rules. It must be borne in mind, however, that this possibility of determining intermediate or self-produced materials is also applicable when the rule of origin of the final good requires a change in tariff classification. Therefore, intermediate materials can be used in rules of origin using both the value content and change in tariff classification criteria.
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Unit VI. Technical Requirements
Objective This unit focuses on the third origin determination criterion: technical requirements, and the different ways of defining them.
Questions for This Unit •
What are technical requirements?
•
How are they included in product-specific rules?
•
What is the impact and applicability of assembly rules?
•
In what other ways can rules be defined?
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VI.1. What are Technical Requirements?
The third criterion used to define the requirements of rules of origin is that of technical requirements. Under this approach, a good will be regarded as originating provided that a production process explicitly specified in the rule of origin takes place in an agreement country. In some cases, the rule of origin only requires that a technical requirement be met. In others, this requirement is combined with value content or change in tariff classification requirements. Most agreements, to a larger or lesser extent, contain rules of this type.
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Sample Rules Containing Technical Requirements: Example 1: “FLAT-ROLLED PRODUCTS OF STAINLESS STEEL, of a width of 600 mm or more, shall be produced from products included in heading 7218 molten and molded or cast in the Member Countries.” This rule of the MERCOSUR agreement establishes that the casting and molding
processes
are
part
of
the
origin
requirement
of
the
above-mentioned flat-rolled products and, therefore, they must be performed in the Member Countries. Example 2: “A change to any good of subheading 2710.19 from any other good of subheading 2710.11 through 2710.99 provided that the good resulting from such change is the product of a chemical reaction, atmospheric distillation or vacuum distillation.” According to this rule of the Colombia-US agreement, the occurrence of a chemical reaction, atmospheric distillation or vacuum distillation confers origin to the product resulting from these processes. In the preceding rule, regardless of the change flexibility that allows the use of non-originating inputs from subheadings 2710.11 to 2710.99, it is established that the chemical reaction, atmospheric distillation or vacuum distillation performed to inputs contained in subheadings 27.10.11 to 27.10.99 will confer origin to all the goods in subheading 2710.19 resulting from these processes. The rules of origin negotiated by the United States for its textile industry, namely, that fabrics be cut and sewn in an agreement country, provides another example of technical requirements. To identify these activities it becomes necessary, for instance, that each part of the garment be cut in an agreement country. 66
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Sample Rule Applicable to United States Textile Goods A change to subheading 6201.91 through 6201.93 from any other chapter, except from heading 51.06 through 51.13, 52.04 through 52.12, 53.07 through 53.08, 53.10 through 53.11, 54.01 through 54.02, subheading 5403.20, 5403.33 through 5403.39, 5403.42 through heading 54.08, heading 55.08 through 55.16, 58.01 through 58.02 or 60.01 through 60.06, provided that: (a) the good is cut or knit to shape, or both, and sewn or otherwise assembled in the territory of one or more of the Parties; and (b) any visible lining material contained in the apparel article must satisfy the requirements of Chapter Rule 1 for Chapter 62.
In the above rule, the wording “cut or knit to shape, or both, and sewn or otherwise assembled”
expressly identifies production
processes that must take place for the goods to be originating. Some additional comments on the preceding rule (please note the use in practice of aspects discussed in this and previous modules): a) How are exceptions defined? (Some at four-digit and others at six-digit levels). b) In addition, note the high number of tariff headings. These exceptions are implicitly establishing that a vast majority of yarns and fabrics must be originating. c) The reference to “Chapter Rule 1 for Chapter 62” shows how origin requirements are included in introductory notes, chapters and
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sections; the origin requirement for materials used in the production of visible lining is specified. This is not the only case of supplementary notes. Indeed, in some agreements, rules of origin based on technical requirements are included as notes in the sections or chapters of annexes containing the agreement’s rules of origin. The annexes to some United States agreements, for instance, establish in their chemicals section the production processes needed to confer origin to products. The annex on specific origin requirements for each subheading establishes rules of origin frequently based on changes in tariff classification. Additionally, these section notes list production processes that indeed take place in an agreement country and thus confer originating status to the resulting goods. Therefore, such production requirements are alternatives to the rules established which, together with tariff headings, make up the section.
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Producers may comply with the rules of origin by selecting any of them, that is to say, they may choose the rule listed together with the tariff headings, or the rules mentioned in the notes at the beginning of the section. In these cases, there is no order of priority between the various technical requirements of such notes, and requirements included in the list of rules of origin. The
origin
determination
criterion
based
on
specific
technical
requirements is also subject to some restrictions, limitations, and special requirements: •
The
first
restriction
technological
is
changes
that that
this can
criterion make
is
sensitive
certain
to
production
processes obsolete thus rendering the rule containing certain technical requirements meaningless. •
Another restriction is related to new products. A new product may be classified in a subheading containing a rule of origin based on a specific technical requirement, which may not be necessarily part of that product’s production process.
•
Finally, the technical requirement criterion entails an additional, implicit requirement for the sectors and products to which it applies.
The
inventory
of
production
processes
used
to
manufacture goods should be kept updated, as technological developments may change the processes included in the rules of origin.
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Figure No. 6.1. Restrictions and Requirements of the Technical Requirement Criterion
Source: Prepared by the author.
VI.2 Assembly and Mounting Processes
A technical requirement usually included in some agreements, such as the rules of origin established within the framework of LAIA and MERCOSUR, is the assembly requirement. In these two cases, the origin requirement is met by performing this production process and complying with a value content requirement. The MERCOSUR-Bolivia agreement, for instance, in paragraph i) of Article 3 “Rules of Origin,� provides as follows:
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“Article 3 The following will be considered originating: ……….. “i) any goods resulting from mounting or assembly operations conducted in the territory of one of the Signatory Parties, even if there is a change in tariff classification, when using non-originating materials, where the CIF port of destination value or the CIF maritime port value does not exceed 40 % of the FOB value of the final good;”
The difficulty with the assembly or mounting technical requirement is that it does not define the process features clearly and accurately. What should
be
understood
by
assembly
and
mounting?
In
general,
agreements do not define the concept and, perhaps because of that, they include an additional value content requirement. As a result, insofar as the process complies with this requirement, the assembly or mounting activity will be understood to be significant enough as to confer origin. Furthermore, the LAIA regime in Resolution 252 contains a clause quite similar to that of the MERCOSUR-Bolivia agreement. This clause includes a paragraph that creates more uncertainty:
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“Goods from participant countries will not be originating if materials of non-participating countries are used to process them into their final shape for sale, and that process consists in simple mounting or assembly, packaging, breaking into batches, parts or volumes, selection and classification, marking, making-up of sets, or other operations that do not entail a substantial transformation process under the first paragraph hereof.�
Implicitly, this paragraph is a list of minimal operations including simple assembly or mounting operations. But, what is a simple assembly or mounting operation? Again, this is left to the interpretation of those involved in the application of the rule of origin, such as exporters, importers and Customs, whose interpretation of what could be regarded as simply assembly work may differ. As discussed in the first module, lack of precision does not help to define origin requirements in a predictable, transparent manner, so that a product can be considered originating. In practice, these regulatory gaps create uncertainty and confusion because participants in trade transactions may consider certain activities as assembly requiring some degree of complexity and involving a certain substantial transformation of the parts of a product, while others may regard them as simple mounting or assembly not conferring origin to the product.
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Figure No. 6.2. Other Technical Requirements
Source: Prepared by the author.
VI.3 Other Ways of Defining Rules of Origin
Sometimes this criterion also encompasses another rule, whereby an input to the good should be identified as originating for the good to be similarly regarded. An example is the requirement to use regional milk to produce the dairy products listed in Chapter 4.
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Table 5. Annex V – Origin Regime Appendix 1 Specific Origin Requirements Agreed Upon by the Republic of Argentina, the Republic of Brazil, and the Republic of Peru NALADISA 96
Description
Specific Requirement
04021000
In powder, granules or other solid forms, of a fat content, by weight, not exceeding 1.5 %
Prepared from milk produced in the Signatory Countries
04022110
Milk
Prepared from milk produced in the Signatory Countries
04022120
Skin of the milk (Cream)
Prepared from milk produced in the Signatory Countries
04022910
Milk
Prepared from milk produced in the Signatory Countries
04022920
Skin of the milk (Cream)
Prepared from milk produced in the Signatory Countries
Source: Prepared by the author.
Finally, a not very widespread use of technical requirements may be seen in the definition of rules of origin in Figure No. 6.3 below. In this case, technical requirements are used in a negative sense:
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Figure No. 6.3. Sample Rule of Origin with Negative Requirements
Source: Prepared by the author.
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List of Figures Figure No. 1.1. Differences Between the Change in Tariff Classification and the Value Content Criteria Figure No. 1.2. Components of the Cost of Goods Figure No. 1.3. Input Content Figure No. 1.4. Different Wording, Same Requirement Figure No. 2.1. Advantages of the Value Content Criterion Figure No. 2.2. Disadvantages of the Value Content Criterion Figure No. 3.1. Possible Requirements of a Rule of Origin Figure No. 3.2. Features of the Net Cost Method Figure No. 3.3. Adjustments for Calculating Net Cost Figure No. 3.4. Recent Value Content Calculation Methods in US Agreements Figure No. 3.5. Build-up Method Figure No. 4.1. Management of Fungible Materials Figure No. 4.2. Allocation of the Non-Fungible Materials Cost Figure No. 5.1. Costs Considered in Non-Originating Materials Figure No. 5.2. Adjustments to Non-originating Materials Figure No. 5.3. Adjustment to Originating Materials Figure No. 5.4. Impact of Adjustments Figure No. 5.5. Concept of Self-Produced or Intermediate Materials Figure No. 5.6. Determination of the Value of an Intermediate Material
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Figure
No.
6.1. Restrictions
and
Module 3
Requirements
of the
Technical
Requirement Criterion Figure No. 6.2. Other Technical Requirements Figure No. 6.3. Sample Rule of Origin with Negative Requirements
List of Tables Table 1. Cost Structure. Impact of Devaluation on Imported Inputs Table 2. Impact of Devaluation on All Costs Table 3. Definition of the RVC in Integration Schemes Table 4. Use of the Net Cost Method in Some Agreements Table 5. Annex V – Origin Regime Appendix 1 Specific Origin Requirements Agreed Upon by the Republic of Argentina, the Republic of Brazil, and the Republic of Peru
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