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NAFTA Rules of Origin
January 1, 2003
By: Lawrence M. Friedman


Certifying goods as "originating" under the North American Free Trade Agreement is more than a matter of completing and signing the Certificate of Origin ("C.O."). It is imperative that producers and exporters asked to complete a NAFTA C.O. understand and properly apply the NAFTA Rules of Origin before certifying merchandise or relying on a C.O. from a supplier.

Products may originate in North America based on one of several rules. The NAFTA C.O. designates these as Preference Criteria A through F. This article provides an introduction to the rules or origin and general guidance on their application. The rules discussed below are subject to many exceptions and details. Consequently, advice concerning a specific circumstance should come from a qualified customs attorney.

The Rules of Origin applicable to any particular product can be found in Annex 401 to the NAFTA. In the United States, the rules are incorporated in the Harmonized Tariff Schedule of the United States as General Note 12. In Canada, the rules are in Customs D-Memorandum D11-5-2. The Mexican version of the rules appeared in the Diaro Oficial on March 27, 1996.


Preference Criterion A: Wholly Obtained or Produced
The NAFTA provides that goods that are "wholly obtained or produced entirely" in North America are "originating." This rule applies where the goods contain no materials that come from outside North America. For example, tortillas made in Mexico entirely from Canadian corn, United States soybean oil and shortening from Mexico are originating under this preference criterion. However, if spices from a country outside North America are added, the tortillas do not qualify under this rule.

Because of the complexity of the global marketplace, it is very unlikely that many industrial products qualify under this preference criterion. Instead, preference criterion A applies most often to agricultural goods and raw materials. The NAFTA lists several examples of qualifying goods including mineral goods extracted in the territory of one or more of the NAFTA parties; vegetable goods harvested in the territory of one or more of the NAFTA parties; and live animals born and raised in the territory of one or more of the NAFTA parties. In addition, goods produced in North America exclusively from combinations of such materials, are originating. Because of the strict requirements of this rule, an importer relying on a NAFTA C.O. claiming preference criterion they advise A to confirm that the supplier properly applied the rule.

An important addition to this rule related to waste and scrap and used goods. The NAFTA provides that waste and scrap derived from production in the territory of one or more of the NAFTA parties is originating. Similarly, used goods collected in the territory of one or more of the NAFTA parties are originating provided they are fit only for the recovery of raw materials. This means that metal shavings from a machining process are originating even if the article being worked originates outside North America. However, used machine parts that can be repaired and reused are not considered originating by virtue of being collected in North America.

Preference Criterion B: Tariff Shifts and RVCs
Preference Criterion B relies on two related tests designed to grant originating status to goods that have undergone substantially processing in North America. The first test is whether the materials used to produce the finished good undergoes a qualifying shift in tariff classification. The shifts are set out by tariff number in Annex 401 of the Agreement and General Note 12(t) to the HTSUS. For example, a camera made in Mexico qualifies as originating if all of the non-originating materials used in the production of the camera changed from another tariff heading to heading 9006. Because parts for cameras are classifiable in subheading 9006.91, if the camera contains any non-originating materials classifiable as parts, it will not qualify under this rule.

An alternative rule may help. A tariff shift from parts of subheading 9006.91 to cameras of heading 9006 will confer NAFTA origin if the Regional Value Content (which is a measure of the North American value added) is sufficiently high. Many rules in Annex 401 have similar alternatives based on an RVC. RVC may be calculated in two ways: the transaction value method and the net cost method.

Transaction Value
The starting point for this method is the transaction value ("TV") of the goods to be certified as originating. Transaction value is the price paid or payable for the merchandise. The other component of the calculation is the value of non-originating materials ("VNM") used in the production of the good. This is the sum of the purchase prices for materials that do not qualify as originating under the agreement. The formula for RVC under this method is:

 

RVC = (TV-VNM)/TV x 100



Usually, if the transaction value RVC exceeds 60% and the non-originating materials make the required change in tariff classification, producer or exporter can certify the article as originating.

Net Cost
Another means of calculating RVC is the net cost method. This method uses the costs of materials, overhead and general expenses as the basis for the calculation. The formula is:
 

RVC = (NC-VNM)/NC x 100



The key to successfully using this method is the proper determination of net cost ("NC") and VNM.

Net Cost is the sum of all product costs, period costs and other costs associated with the production of the good less specified excluded costs. The excluded costs include non-production overhead expenses including costs associated with warranties, marketing, after sales service and some interest costs. Expenses incurred for the production of more than one product must be allocated to the good being certified. The NAFTA rules provide specific means for doing that allocation. VNM under the net cost method is usually determined in the same manner as under the transaction value method. Most often, the rules of origin require an RVC of 50% plus the applicable tariff shifts.

Certifiers can usually choose to apply either method. Generally, the transaction value method is easier to administer because it does not require as detailed a cost analysis. Both methods require an analysis of the bill of materials to identify tariff shifts and the value of non-originating materials. However, the threshold for qualification under the transaction value method is higher (the fact that the transaction value includes profit partially offsets this). The net cost method, on the other hand, requires an analysis of the cost of production.

The certifier may not use the transaction value method where there is no transaction value for the goods (such as where the goods are not the subject of a sale). Similarly, net cost must be used where the volume of sales by that producer of identical goods or similar goods to related persons during the six-month period immediately preceding the month in which the producer sells the goods exceeds 85 percent of the producer's total sales to all persons. The transaction value method is also not applicable to motor vehicles and most motor vehicle parts sold for use as original equipment. A certifier who uses the net cost method may not switch to the transaction value method although the rules permit the opposite switch.

Preference Criterion C: Goods Made Exclusively of Originating Material
When all of the materials used in the production of a good are originating materials, preference criterion C applies. This differs from preference criterion A in that the originating materials may contain material that originated outside North America. For example a manufacturer may make bicycle frames from Korean steel. When the steel is processed into parts, the parts may be originating under the applicable tariff shift and RVC rule. If the bicycle manufacturer uses those frames, and no non-originating materials, the bicycle will be originating under preference criterion C.

Preference Criterion D: Unassembled or Disassembled Goods, Parts
Because of certain classification rules, some merchandise will never undergo a tariff shift from processing in North America. One example of this is where the tariff schedule classifies parts with the complete article. As a result, the imported parts have the same classification as the assembled article. Another example is where a complete but disassembled article is imported. Customs classifies such articles as if they were assembled. Thus, no tariff shift will take place because of the assembly process. In these cases, the NAFTA rules permit the producer or exporter to certify the good provided it has a RVC of 50% by the net cost method or 60% by the transaction value method.

Preference Criteria E and F:
Preference criterion E is a departure from the other rules of origin in that it does not require any physical processing or value added. Instead, this rule states that specified electronic and computer equipment can be treated as originating when the non-preferential most favored nation rate of duty applicable in the three NAFTA countries is the same. The basis for this rule is that any non-originating materials in this category were subjected to duty when first entering North America. Duty having been paid, the parties to the NAFTA agree that no further payment is necessary. Preference criterion F relates to certain agricultural commodities that are subject to quantitative import restrictions. Under this rule, if the goods are originating under preference criterion A, B or C, the quantitative restriction is inapplicable.

Special Rules:

The De Minimis Rule

Goods that contain small amounts of non-originating materials that fail to undergo the applicable change in tariff classification may qualify as originating. Under the de minimis rule, if the value of that material is 7% or less of the transaction value of the good, it qualifies under preference criterion B. For textiles, the rule is 7% of the total weight of the article. If, however, the good is subject to a RVC requirement, the VNM must include that value. VNM. Finally, if the good is subject to a RVC requirement but contains a total value of non-originating material of 7% or less of the total value, the RVC is not applicable. There are many exceptions and modification to the de minimis rule that certifiers must consult when seeking to apply it.
 

Averaging

To permit producers to certify groups of goods produced over time, the NAFTA permits averaging in a number of contexts. It is, for example, possible to average costs of similar goods produced in the same factory. This helps ease the burden of certification where costs vary over time and may permit the certification of low RVC goods where there are also high RVC goods to include in the average. Averaging can also be used to account for differences in sourcing. This permits a manufacturer who uses originating and non-originating fungible materials to use a rolling average to fix the origin of specific materials used in production without having to specifically track materials through the inventory and production control system.
 

Accumulation and Intermediate Materials

When two or more locations in North America are involved in the production of the good, the certifier may include costs incurred in both locations in its net cost RVC calculation. This is accumulation.

Another helpful rule permits producers to designate self-produced materials as originating and treat them as such when certifying finished goods. Thus, a bicycle manufacturer who makes seats from non-originating materials may be able to certify the seats as originating intermediate materials. This depends upon the application of the rules of origin to the seat as if the seat were the finished good. Where the intermediate material is subject to a RVC requirement, it is not permissible to designate it an intermediate material, use it in the production of another material that is also subject to a RVC requirement and designate that as an intermediate material.
 

Automotive Tracing

The motor vehicle and motor vehicle parts industry is subject to a number of unique and complicated NAFTA rules most of which relate to the calculation of RVC. For automotive goods, producers and exporters must calculate RVC from the net cost method. The rules of origin specify that the calculation of VNM must include the value of some input materials used by suppliers to the automotive goods producer. This is tracing. To complicate things more, the NAFTA has different tracing rules for light and heavy-duty goods.

Light-duty automotive goods are light vehicles and specified parts for use in the production of new light-duty vehicles. The tracing rules require that the VNM of light-duty automotive goods include the value of non-originating parts specified on the so-called "tracing list." This may include materials used by unrelated suppliers in the production of materials sold to the producer of the light duty automotive good. For example, electric motors are traced material. Thus, if a car seat manufacturer uses a non-originating motor in the production of a car seat it sells to a passenger vehicle manufacturer, the VNM of the vehicle must include the value of the non-originating motor. The corollary to this is that if the non-originating materials are not on the tracing list, they are treated as originating. This produces a benefit for some parts of the industry. Tracing, therefore, places a difficult burden on producers to collect cost data from suppliers.

Heavy-duty tracing focuses only on engines and transmissions. This rule requires that producers include the value of all non-originating materials used in the production of engines and transmissions in the VNM of those components and the vehicles in which they are used.

Conclusion
The NAFTA rules are complex and cumbersome. Without great care and proper training, it is likely that certifiers will make mistakes completing NAFTA Certificates of Origin. These mistakes may result in the incorrect certification of non-originating goods or the loss of duty reduction opportunities for originating goods that were not certified. In addition, a lack of a thorough knowledge of the requirements will greatly increase the difficulty in responding to a verification request from the Canadian, U.S. or Mexican customs authorities. It is, therefore, necessary that certifiers and importers making NAFTA claims learn and understand the NAFTA rules of origin or seek the assistance of experts in the field.
 

Lawrence M. Friedman is a partner at Barnes, Richardson & Colburn. He can be reached at (312) 565-2000 or lfriedma@brc-chi.com. This article should not be considered legal advice as that requires a complete understanding of all the relevant facts.

 

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