The Essentials of the USMCA

The United States-Mexico-Canada Agreement (“USMCA”) replaced NAFTA effective July 1, 2020. Except for certain agricultural products, it provides duty free treatment for all goods traded between the three countries which “originate” among them.

What does that term – originate – mean? We’ll start by describing two types of exports that do not originate under the USMCA, or indeed any free trade agreement. We will then move on to those that do.

First, a good does not originate simply because it is exported from one member country to another. For example, a television set manufactured in China, shipped to a warehouse in Mexico for storage, and then shipped to a retailer in the United States, is not entitled to duty free treatment under the USMCA. It will be subject to duties, if any, under the American tariff code for television sets that originate in China.

Second, a good manufactured in the United States, Mexico or Canada does not automatically qualify as originating under the USMCA. This appears counter-intuitive. The confusion arises because there are two types of origin in international trade – non-preferential and preferential.

Non-preferential origin assigns a home country, or economic nationality, to every good that crosses a border anywhere on Earth.

If the good is wholly composed of components or materials derived from and, if applicable, processed in a single country, that is its country of non-preferential origin. For substantially all these kinds of goods, the country of non-preferential origin will also be the country of preferential origin under a free trade agreement such as the USMCA. For example, wheat grown in Canada is of Canadian origin (preferential and non-preferential), as is multigrain flour milled in Canada using only grains and other ingredients grown in Canada.

It becomes more complicated where a good contains components or ingredients from more than one country. In that case, the country of non-preferential origin is the country where the last “substantial transformation” in production occurs. Each country interprets this principle in a different way. As an example, the United States Customs and Border Protection (CBP) agency states that, in its view, “substantial transformation means that the good underwent a fundamental change (normally as a result of processing or manufacturing in the country claiming origin) in form, appearance, nature, or character, which adds to its value an amount or percentage that is significant in comparison to the value which the good (or its components or materials) had when exported from the country in which it was first made or grown.”

Unless the last production process is minor, a television set assembled in Mexico from components made in numerous countries will be of Mexican non-preferential origin. However, it may or may not be of Mexican preferential origin under the USMCA.

The USMCA Rules of Origin for goods containing components or materials originating outside the United States, Canada or Mexico are not based on the broad principle of substantial transformation. Rather, these rules are product specific, quite detailed and 208 pages long.  The Product-Specific Rules of Origin (“PSROs“) follow the Harmonized System (HS) of tariff classification used by almost all developed countries. There are two main criteria for qualifying under the PSROs:

• Tariff shift – a comparison of the tariff classification of the raw materials as they existed before production to the tariff classification of the finished good.
• Regional value content – in general terms, the ratio of the value of production within the United States, Canada and Mexico to the selling price or cost of the finished good.

For example, a television set is classified under subheading 8528.72, which forms part of heading 85.28. The PSRO for heading 85.28 provides that a finished good classified within it will qualify a originating if either (a) every non-originating component or material used to make it is classified outside heading 85.28 (tariff shift test), or (b) there is a regional value content of not less than 60% under the transaction value method or 50% under the net cost method.

The tariff shift test is generally easiest to apply. In addition to television sets, heading 85.28 includes monitors (8528.59) and reception apparatus for television without a monitor (8528.71). If either of these components originates in a country outside the United States, Canada or Mexico, the finished set will not qualify under the tariff shift test. However, it might qualify under the regional value content test, which involves some cost accounting.

Not all tariff codes in the PSROs provide an option between tariff shift and regional value content tests. Some specify one or the other and some require both. Further, there are four origin criteria under the USMCA, of which three relate to different circumstances where the good contains materials or components from outside North America.

Details of how the tariff shift and regional value content categories are applied are further described in an article entitled Determining Origin Under the USMCA available elsewhere on this website.

If the goods you make meet the Rules of Origin, you will need to document your conclusions. The basic document is a list of all the raw materials, organized into two categories: originating and non-originating. This is known as a Bill of Materials. You will generally need letters or certifications of origin from suppliers of originating materials indicating that they qualify. If a tariff shift test is being applied, the non-originating materials must be classified under the HS to demonstrate that all of them meet the test. If the regional value content test is being applied, you will need to value all the non-originating materials and calculate the transaction value or net cost.

This may involve a fair amount of work. There is no point in doing it if the goods are duty free in the country of import under general international trade rules (known as Most Favored Nation, or MFN). The work may also not be worthwhile if the rate of duty is nominal, say 2% or less.

An importer who claims duty free treatment under the USMCA must have a certification of origin in its possession. This certification is not provided with the import documents; however, it may be requested by the customs authority in the country of import. There is no prescribed form of certification (as there had been with NAFTA). However, a specified set of data elements must be set out on the invoice or other document.

The certification of origin may be prepared by the producer, exporter or importer. The documentation that each is requited to maintain is described in a separate article on this website.

If you have questions or comments on these issues, please email peter@mitchelltrade.com or call us at 403-462-0835.