The Hidden Implications of FTA Origin Audits

Importers who claim preferential tariff treatment under a free trade agreement (“FTA”) are generally familiar with the certificate of origin provided by the exporter or producer of the goods. In most FTAs, importers are required to have this certificate in their possession at the time the preferential treatment is claimed.

Many importers assume that the certificate of origin is the end of the story or that it shields them from liability should the goods subsequently be found not to originate. Unfortunately, this is not the case.

It is the importer who must pay the duties owing plus interest, and perhaps also penalties, should the certificate be invalid. This can come as an expensive surprise. For example, assume a Canadian importer purchases $10 million of goods from a German supplier over four years. They have certificates from the producer which state the goods originate under CETA and are thus duty free. A verification audit determines that the goods did not qualify under the CETA Rules of Origin, and are subject to the MFN rate of 6.5%. The assessment of duties would be $650,000. With penalties and interest, the total bill could be over a million dollars.

Where preferential tariff treatment under an FTA is critical to an importer, they might consider negotiating a provision in the sales contract whereby the exporter guarantees that the goods originate and agrees to pay the duties, interest and penalties assessed if they do not. At a minimum, the importer should take reasonable steps to ensure that the producer has done the work necessary to conclude that the goods originate. They should also review the certificate for “red flags”. For example, a producer who states that a complex piece of machinery is “wholly obtained or produced” in the countries that are party to the FTA likely doesn’t understand origin very well. That category would only apply of every part and all the raw materials in them came from those countries.

The customs authority in the importing country (“Importing Authority“) has the right to initiate the verification or audit of a claim for preferential tariff treatment. This generally begins with the Importing Authority requesting from the importer a copy of the certificate of origin and perhaps other information. If the Importing Authority requires further information, they will contact the exporter, producer and/or suppliers of raw materials to the producer. Under some FTAs, such as the USMCA and CPTPP, this is done directly. For example, the Canada Border Services Agency (“CBSA“) has the right to contact an exporter, producer or supplier in the United States or Mexico to initiate a verification audit under the USMCA. Under other FTAs, such as Canada’s agreements with the European Union (CETA) and the United Kingdom (CUKFTA), the Importing Authority contacts the customs authority in the exporting country, who in turn conducts the verification audit of the exporter, producer or supplier.

A verification audit usually begins with a questionnaire such as Form B231 that was sent by the CBSA to producers in the United States and Mexico where an origin claim under NAFTA was based on tariff shift. When it is published, the corresponding USMCA questionnaire should be virtually identical. A corresponding CETA, CUKFTA and CPTPP questionnaire would be similar. The key information requested is:

  1. a description of the finished good, with product literature and tariff classification;
  2. a description of the production process;
  3. a list of the raw materials, segregated between originating and non-originating, and their suppliers, and
  4. the tariff classification of non-originating raw materials.

A producer who has done the work necessary to substantiate origin should not have trouble completing the questionnaire. It would have kept documentation and analysis in generally the same format. If the customs authority is satisfied that the questionnaire has been properly completed and reached the correct conclusion, the verification audit would likely end there and there would be no adjustment to the duties paid.

An exporter, producer or supplier who receives a questionnaire is not obligated to respond. However, if they do not, the result will likely be an assessment against the importer.

If the exporter, producer or supplier does respond, but the customs authority is unable to conclude from it that the goods originate, it may request a visit of the producer’s production facilities. Again, the producer does not have to consent. However, if they do not the importer will likely be assessed.

Should the importer be assessed at any of these stages, including after a visit by the customs authority to the producer’s premises, they will have the right to appeal.

The CBSA has set out the details of origin verification procedures for NAFTA (predecessor to the USMCA) and other free trade agreements in its Memorandum D11-4-20, and for CETA and CUKFTA in Memorandum D11-4-21. The details for CPTPP have not been published in a Memorandum but are set out in Articles 3.27 and 3.28 to the Agreement.

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