Customs duties may vary considerably depending on origin. For example, a pair of soccer boots imported into Canada is subject to duty at 17.5% if it originates in Indonesia but is duty free if it originates in Bangladesh.

Non-preferential origin

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 a single country, that is its country of non-preferential origin. For example, wheat grown in Canada is of Canadian non-preferential origin, 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 slightly different way.

The United States Customs and Border Protection (CBP) agency states that “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.”

In its March 2022 publication Guidance on Non-Preferential Rules of Origin, the European Union states that substantial transformation occurs “where goods underwent their last, substantial, economically-justified processing or working, in an undertaking equipped for that purpose, resulting in the manufacture of a new product or representing an important stage of manufacture.”

For the majority of manufactured goods, it is usually clear that a substantial transformation has occurred. The issues occur on the margins where the manufacturing or processing operations are less substantive. Unfortunately, there is no “bright line” test to determine when the threshold has been crossed. In its Guidance publication, the European Union states that the following operations do not confer origin:

• operations to ensure the preservation of products in good condition during transport and storage (ventilation, spreading out, drying, removal of damaged parts and similar operations) or operations facilitating shipment or transport;

• simple operations consisting of removal of dust, sifting or screening, sorting, classifying, matching, washing, cutting up;

• changes of packaging or breaking up and assembly of consignments, simple placing in bottles, cans, flasks, bags, cases, boxes, fixing on cards or boards and all other simple packaging operations;

• the presentation of goods in sets or ensembles or presentation for sale;

• the affixing of marks, labels or other distinguishing signs on products or their packaging;

• simple assembly of parts of products to constitute a complete product;

• disassembly or change of use; or

• a combination of two or more of the operations specified above.

In October 2018 the Law Offices of George R. Tuttle, located in San Rafael, California, published an excellent article summarizing the United Sates jurisprudence on the subject of substantial transformation. The article will be useful to anyone struggling with which side of the line their product falls. The following excerpts provide a sense of its substance.

“In recent years Customs and the courts have concentrated on change in use or character of the components or materials when processed into finished goods, and sometimes finding other various subsidiary tests appropriate to consider, depending on the situation at hand. …. Courts have held that when the properties and uses of a product are predetermined by the material from which it was made, no substantial transformation occurs.“Character” is defined as the “mark, sign [or] distinctive quality” of a thing. …. For courts to find a change in character, there often needs to be a substantial alteration in the characteristics of the article or components. …. Changes that are deemed cosmetic are insufficient for a finding of substantial transformation. In analyzing whether there is a change in use, the court has found that such a change occurred when the end use of the imported product was no longer interchangeable with the end use of the product after post-importation processing. …. When the end use was predetermined at the time of importation, courts have generally not found a change in use.”

The Canada Border Services Agency does not provide a definition of substantial transformation. However, they do say in Memorandum D-1-4 that “Certain operations such as packaging, splitting, and sorting may not be considered as sufficient operations to confer origin.”

Preferential origin

Preferential origin refers to the Rules of Origin in a free trade agreement. Canada has many free trade agreements with individual nations. However, the most important agreements are multi-national: the USMCA with the United States and Mexico, the CPTPP with ten nations around the Pacific Rim and CETA with the 27 countries of the European Union.

Where a good is wholly composed of components or materials derived from a single country, that is generally its country of preferential as well as non-preferential origin.  For example, wheat grown in Canada meets the Rules of Origin under the CPTPP when shipped to Japan. Flour milled entirely in Canada from wheat grown in Canada meets the Rules of Origin under CETA when shipped to Germany, and under the USMCA when shipped to the United States.

However, where components or materials originate in countries other than the parties to a free trade agreement, the rules of origin under that agreement are not based on the principle of substantial transformation. Rather, the rules are generally product specific, detailed and often several hundred pages long. These “Product-Specific Rules of Origin” (“PSROs“) follow the Harmonized System (HS) of tariff classification. There are generally three 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 free trade area (e.g., the United States, Canada and Mexico with the USMCA) to the selling price or cost of the finished good.

• Transformation – a transformation, such as a chemical reaction, that occurs within the production process.

For example, let’s say soccer boots manufactured (and substantially transformed) in the United States are imported into Canada. Some of the raw materials and components originated outside Canada, the United States and Mexico. The boots will be of United States non-preferential origin.

Under the PSRO that includes soccer boots (heading 62.02), the boots will be of United States preferential origin under the USMCA if they meet both a tariff shift test and a regional value content test whereby at least 55% of the cost of the boots must be incurred in Canada, the United States or Mexico. If the boots satisfy both tests, they may be imported into Canada duty-free. If not, the duty rate will be 17.5%.

Common misconception

A common misconception is that goods originate in the country from which they are shipped to the country of import. That is not true. For example, a pair of soccer boots manufactured in Indonesia, shipped to a warehouse in the United States, and subsequently sold to a customer in Canada, remains of Indonesian non-preferential origin. Further, they do not qualify for preferential duty free treatment under the USMCA.