Proposed Rules Streamline Country of Origin Determinations for Mexican and Canadian Imports

On July 6, 2021, U.S. Customs and Border Protection (“CBP”) and the Department of the Treasury proposed rules that would simplify the non-preferential rules of origin for goods imported from Mexico or Canada. This proposed rulemaking could significantly impact companies that import to the United States from these countries, including for purposes of government procurement and U.S. Section 301 tariffs imposed on Chinese imports. Additionally, an interim final rule issued concurrently by CBP and Treasury confirms that for purposes of marking under the United States-Mexico-Canada Agreement (“USMCA”), rules of origin based on tariff classification changes continue to apply, thereby maintaining the status quo.

Background

Importers must declare to CBP the country of origin of every good imported to the United States. Correctly determining origin is important because it can affect applicable tariffs, the availability of special preferences under free trade agreements, eligibility for government procurement, and other regulatory requirements related to importation.

Rules of origin fall into two general categories—preferential and non-preferential. Preferential rules of origin determine whether a good is eligible for special treatment such as reduced duty rates under free trade agreements or special trade programs like the Generalized System of Preferences. Non-preferential rules are those that apply for all other purposes, including marking, eligibility for government procurement, the application of special duties imposed under Section 301 of the Trade Act of 1974 (“Section 301”), and safeguard measures.

For non-preferential purposes, CBP currently applies two different legal tests for determining country of origin:

• The default test involves a case-by-case adjudication to determine the last country in which the product underwent a “substantial transformation” into a new and different article of commerce. Applying court cases and past administrative rulings, CBP considers whether manufacturing operations for the specific good at issue resulted in a change in name, character, or use. Oftentimes, this is a difficult and fact-intensive inquiry given the complex and global nature of many supply chains, and importers may find it challenging to predict how CBP would rule on their products.
• The second test applies to imports from Canada and Mexico for the specified purpose of country of origin marking.[1] As agreed by the U.S., Canada, and Mexico in the NAFTA, this test applies relatively mechanical “tariff shift” rules based on whether certain inputs underwent a change in tariff classification in the course of producing the finished product. These non-preferential tariff shift rules are codified at 19 C.F.R. Part 102 (“Part 102”) and are known as the “NAFTA marking rules.”[2] In July 2020, the USMCA entered into force, along with new preferential rules of origin provided in the Uniform Regulations (See our prior alert here). Because USMCA, unlike NAFTA, does not have a chapter providing for marking rules, there had been a question of whether the Part 102 rules would be revoked and replaced by the case-by-case “substantial transformation” test. In its USMCA Implementing Instructions, however, CBP announced that the Part 102 NAFTA marking rules would continue to apply, with a narrow exception.[3]

In summary, at present, imports from Mexico and Canada are governed by two distinct non-preferential rules of origin. In the specific context of marking, the Part 102 rules apply; for other non-preferential purposes—for instance, for government procurement eligibility and application of Section 301 duties—origin is governed by the case-by-case “substantial transformation” test.

Proposed Rulemaking and Interim Final Rule

The proposed rules affect only the non-preferential rules of origin applicable to goods imported into the United States from Mexico and Canada. Specifically, for these imports, the proposed rules expand the coverage of the Part 102 tariff shift rules to include all non-preferential purposes, thereby replacing the case-by-case “substantial transformation” test that currently applies in many contexts.

If promulgated, the proposed rules could have significant implications for goods imported from Mexico and Canada. Although CBP’s position is that the case-by-case test and Part 102 tariff shift rules are meant to effect the “same substantial transformation standard,” the notice also acknowledges that the case-by-case test “often involves subjective judgments as to what constitutes a new and different article or as to whether processing has resulted in a new name, character, and use” and can result in “a lack of predictability.” By comparison, the notice explains that the Part 102 rules are “a reliable, simplified, and standardized method” for country of origin determinations. In practice, these rules are less subjective and often easier to apply. Moreover, at least in a meaningful subset of cases, the two tests yield different outcomes: for instance, a good can be Mexican for purposes of USMCA marking, while originating from China for purposes of Section 301 tariffs[4] (The opposite combination is also possible, though less likely). Under the proposed rules, the prospect of dual non-preferential countries of origin would be eliminated for goods imported from Canada and Mexico.[5]

Importantly, the proposed rules do not affect country of origin determinations made by the U.S. Department of Commerce in antidumping and countervailing duty (“AD/CVD”) investigations. The legal standards applied by Commerce in administering the scope of AD/CVD investigations and orders remain unchanged.[6]

An interim final rule published concurrently with the notice of proposed rulemaking provides that, among other things, the Part 102 rules of origin continue to apply to the marking of goods from Mexico and Canada. The interim final rule, therefore, maintains the status quo with respect to marking and generally codifies the USMCA Implementing Instructions.[7] The interim final rule is effective as of July 1, 2021—five days prior to its publication.

Implications for the Trade Community

Importers and others in the trade community should assess how the proposed rules would impact their business and trade compliance operations.

For instance, with respect to the proposed rules, importers may need to assess tariff classifications of inputs brought into Mexico or Canada for final assembly in order to determine whether a tariff shift occurs that would enable a claim of Mexican or Canadian origin under Part 102 when the final product is imported into the United States. A careful review of import data can also help an importer assess the degree to which the proposed rules would affect duty exposure and compliance workflows. Importers should note that the proposed rules would not alter the rules of origin for goods imported from countries other than Mexico or Canada. The non-preferential rules in that context would continue to be based on case-by-case adjudications under the traditional “substantial transformation” test.[8]

If the proposed rules will have significant impacts on your company’s business, either positive or negative, consider submitting a comment by the deadline of August 5, 2021. Among these impacts could be the risk that goods currently identified as Canadian or Mexican under the case-by-case “substantial transformation” test might instead become goods of China under the Part 102 rules, and thereby subject to Section 301 tariffs. More generally, importers should assess whether the proposed rules would increase or decrease their overall duty burden (In this regard, note that CBP has not yet determined the effective date of the proposed rules, so the current origin rules remain in place, and absent retroactivity—which is unlikely—importers would not receive any duty refunds if and when the rules change). Another area of potential concern is whether the application of the streamlined Part 102 tariff shift rules only as to goods from Mexico and Canada may be inconsistent with World Trade Organization (“WTO”) rules prohibiting discriminatory treatment in government procurement and more generally in imposing import duties and related regulations.

Similarly, companies have the opportunity to submit comments regarding the interim final rule by the deadline of September 7, 2021.

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Covington routinely helps clients navigate supply chain and customs compliance challenges. Among other matters, we have helped companies assess duty exposure and opportunities for duty savings under preferential and non-preferential rules of origin; request country of origin rulings, including for goods subject to Section 301 duties; analyze implications of the USMCA; and design import compliance programs.

If you have any questions concerning the material discussed in this client alert, please contact the members of our International Trade and Public Policy practices.