This article provides a summary of the Rules of Origin under the United States-Mexico-Canada Agreement (“USMCA“), which replaced the former North American Free Trade Agreement (“NAFTA“) effective July 1, 2020.
The basic criterion for “origination” under the USMCA is that a good be produced in United States, Canada or Mexico, or a combination of those countries (collectively, “North America“). The term “production” is broadly defined to mean growing, cultivating, raising, mining, harvesting, fishing, trapping, hunting, capturing, breeding, extracting, manufacturing, processing or assembling a good, or aquaculture.
Production within North America does not by itself mean that a good will be considered to originate. Indeed, some goods that are of Canadian, American or Mexican “non-preferential origin” will not meet the test for “preferential origin” (with limited exceptions, duty-free treatment) under the USMCA. The basic principles of these two types of origin, and the difference between them, are discussed in the article The Basics of Origin in International Trade.
The good must fall into one of the following four “origin criteria”, which are designed to ensure that the value added from production in North America is significant:
- Goods Wholly Obtained or Produced (Article 4.2(a) of the Agreement);
- Goods Produced Exclusively from Originating Materials (Article 4.2(c));
- Product-Specific Rules of Origin (Article 4.2(b)); or
- Disassembled Goods, Parts, etc. (Article 4.2(d))
The nature of each criterion, and the rules applicable to it, are summarized below. These rules distinguish between “goods” and “materials”. A good is a finished good as it exists after production. A material is a good used to produce a finished good.
Materials may be either direct or indirect. Direct materials are incorporated into and become part of the finished good: for example, the leather and zipper in a leather jacket.
Indirect materials are materials used in the production, testing or inspection of a good, but not physically incorporated into the good, or materials used in the maintenance of buildings or the operation of equipment associated with the production of a good. Examples include fuel, lubricants, catalysts, solvents, tools, dies and molds.
The following materials that are shipped with a good, but do not form part of it, are treated differently under each criterion, as described below:
- accessories, spare parts, tools and instructional and other informational materials delivered with the good and not invoiced separately (“Accessories”);
- packaging materials and containers in which the good is packaged for retail sale (“Retail Packaging”); and
- packing materials and containers for shipment of the good (“Shipment Packing”).
1. Goods Wholly Obtained or Produced
This is the most fundamental and simplest of the origin criteria. It includes products obtained from the earth and sea and goods produced entirely from them: minerals mined or extracted; crops grown or harvested; live animals raised, fished or hunted, and products derived from those animals. Examples include cattle, steak, grains, whole and filleted fish, fruits, vegetables, coal, crude oil and copper.
This criterion may only be claimed where the good and all materials used to produce it contain no ingredients or components that were obtained or produced outside the Region. However, Accessories, Retail Packaging and Shipment Packing may originate anywhere.
2. Goods Produced Exclusively from Originating Materials
This criterion includes goods produced entirely from materials, including Accessories and Retail Packaging, that originate within the Region (even if some of the components in the materials did not originate). The origin of Shipment Packing is disregarded.
For example, this would be the proper criterion for a leather jacket if all the direct materials originated in Canada, the United States and/or Mexico. However, the metal in the zipper and fasteners could have originated elsewhere.
3. Product-Specific Rules of Origin
This is the most common category in practice. It includes goods which contain one or more direct materials that originate outside the Region (“Non-Originating Materials”) or are of unknown origin. A Non-Originating Material is one that is
- imported from a country outside the Region, or
- produced within the Region but does not satisfy any of the four origin criteria.
The Product-Specific Rules of Origin (“PSROs”) are set out at Annex 4-B to Chapter 4 (starting at page 17). They are 208 pages long and quite detailed. The PSROs follow the Harmonized System (HS) of tariff classification used by almost all developed countries, including Canada, the United States and Mexico. There are three categories of PSRO:
- Tariff shift – a comparison of the tariff classification of the direct 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 Region to the selling price or cost of the finished good.
- Transformation – a transformation, such as a chemical reaction, that occurs within the production process.
In many cases, only one category of PSRO applies to a particular good. However, in other cases there is a choice between two, or even all three. For example, the PSRO for subheading 3005.10 (adhesive dressings and other articles having an adhesive layer) specifies either a tariff shift from any heading outside heading 3005, or a regional value content in the finished good of at least 60% under the transaction value method or 50% under the net cost method.
An Appendix to Annex 4-B includes additional provisions that apply only to automotive goods.
A. Tariff Shift
A good qualifies as originating under the tariff shift category when the tariff classification of every Non-Originating Material and material of unknown origin meets a test set out in the PSRO for the finished good. For example, a leather jacket is classified under subheading 4203.00: “articles of apparel and clothing accessories, of leather or of composition leather”. Goods classified under that subheading qualify as originating when all Non-Originating Materials are classified outside Chapter 42 (the chapter that includes subheading 4203.00). Chapter 42 covers “articles of leather; saddlery and harness; travel goods, handbags and similar containers; articles of animal gut (other than silk-worm gut)”.
Let’s assume a leather jacket is manufactured in Mexico. The Non-Originating Materials include tanned leather imported from Brazil, a metal zipper imported from Germany and snap fasteners imported from China. Tanned leather is classified in chapter 41 under subheading 4104.11. Metal zippers are classified in subheading 9607.11 and snap fasteners in subheading 9606.10. Both are in Chapter 96. Since all three Non-Originating Materials are classified outside Chapter 42, the leather jacket would be considered to originate under the USMCA. It may be imported duty free into the United States or Canada.
With certain exceptions, the product-specific rules of origin provide a “de minimis” test such that a good is considered to originate if the value of direct Non- Originating Materials that do not meet the tariff shift test is 10% or less of either the transaction value or total cost of the good. For example, if the snap fasteners incorporated into the leather jacket had for some strange reason been classified in Chapter 42, the jacket would still originate if the value of the snap fasteners constituted less than 10% of the transaction value or total cost.
Indirect materials are deemed to be originating without regard to where they are produced. The origin of Accessories, Retail Packaging and Shipment Packaging is ignored.
B. Regional Value Content
Certain of the PSROs provide a regional value content test as an alternative if the tariff shift test cannot be met. Certain other PSROs require both a tariff shift and a minimum regional value content.
In broad terms, the regional value content is the ratio of the value of production within the Region to either the “transaction value” or “net cost” of a good. In most cases, the importer, exporter or producer may use either method. However, in certain cases the net cost method must be used.
Transaction Value Method
The transaction value (defined on page 4 of Chapter 4) is based on “the price paid or payable” for the finished good, generally the producer’s selling price adjusted in accordance with Articles 8(1), 8(3) and 8(4) of the Customs Valuation Agreement maintained by the World Customs Organization (WCO). This principle applies whether the sale is to a buyer in one of the other countries in the Region, or to a domestic intermediary who subsequently exports the good. Articles 8(1), 8(3) and 8(4) are set out, with Explanatory Notes, on pages 19 to 22 of the Brief Guide to the Customs Valuation Agreement published by the WCO.
Rather than try to calculate the regional value content directly, we back into it by first determining the value of all Non-Originating Materials, and then deducting that value from the transaction value. The difference is the regional value content. We then divide the regional value content into the transaction value, expressing the result as a percentage. For example, if the transaction value is $100 and the value of non-originating materials is $35, the regional value content is 65% (100-35/100).
The value of a material used in the production of a good is generally the purchase price adjusted in accordance with Articles 4.6 and 4.7 (page 9 of Chapter 4).
Net Cost Method
The calculation of regional value content under the net cost method is the same as under the transaction value method, using net cost instead of transaction value. “Net cost” means the “total cost” less certain excluded costs discussed below. Total cost (defined on page 4 of Chapter 4) generally includes all costs of operating a production facility and business, allocated to the specific good at issue under one of the three alternatives set out in Article 4.8(8) (page 8 of Chapter 4).
The excluded costs are royalties; sales promotion, marketing and after-sales service costs; shipping and packing costs; and non-allowable interest costs. Each of these excluded cost categories is defined at pages 2 to 4 of Chapter 4.
The difference between the transaction value and net cost of a good is generally the profit and excluded costs.
The net cost method is usually more difficult to apply than the transaction value method because production and other costs must be allocated between the various goods produced. Fortunately, the Uniform Regulations allow a producer to use the same allocation methods for direct materials, direct labour and overhead that it uses for internal cost accounting purposes, if those methods are reasonable and follow generally accepted accounting principles.
In calculating the regional value content of a good, one may add to that content the value of any processing of non-originating materials undertaken by a supplier in the Region, and the value of any originating materials used by a supplier in production of non-originating materials in the Region. This “accumulation” principle may be useful where a producer who cannot meet a regional value content threshold based on its own costs and values has suppliers of non-originating materials produced within the Region. The supplier must be willing to provide the relevant cost and other information, and has no obligation to do so.
It is worth noting that the converse of the accumulation principle does not apply. Once a material is originating, its full value is added to the regional value content. The value of any processing outside the region, or of any non-originating materials used to produce the originating material, are not deducted.
In calculating the regional value content, the value of Accessories and Retail Packaging must be taken into account as originating or non-originating. However, the value of Shipment Packaging is ignored.
There are a limited number of cases where regional value content is measured by weight or volume rather than value.
Transformation in the Production Process
The PSROs for chapters 27 through 40 provide that certain transformations which take place during production in the Region confer origin, regardless of whether a good meets a tariff shift and/or regional value content test which may also be available. In each case, the rules and definitions should be reviewed carefully to ensure that the production process qualifies.
For example, any good of Chapter 27 (Mineral Fuels, Mineral Oils and Products of their Distillation; Bituminous Substances; Mineral Waxes) that is the product of a chemical reaction is considered to originate. Further, any good of heading 2710, which generally contains the products of crude oil refining (gasoline, diesel fuel, fuel oil, kerosene, lubricating oils, etc.) is considered to originate if it is the product of atmospheric distillation, vacuum distillation, catalytic hydroprocessing, catalytic reforming, alkylation, cracking, coking or isomerization.
Any good of Section VI of the HS (Products of the Chemical or Allied Industries) is considered to originate of it meets any of the following rules as they are defined at the beginning of that section of Annex 4-B: chemical reaction, purification, mixtures and blends, change in particle size, standards materials, isomer separation, separation prohibition, and biotechnological processes. Section VI contains the following chapters:
- 28. Inorganic Chemicals; Organic or Inorganic Compounds of Precious Metals;
- 29. Organic Chemicals
- 30. Pharmaceutical Products
- 31. Fertilizers
- 32. Tanning or Dyeing Extracts; Tannins; Dyes; Pigments; Paints; etc.
- 33. Essential Oils and Resinoids; Perfumery, Cosmetic or Toilet Preparations
- 34. Soap; Organic Surface-active Agents; Washing Preparations, etc.
- 35. Albuminoidal Substances; Modified Starches; Glues; Euzymes
- 36. Explosives; Pyrotechnic Products; Matches; Pyrophoric Alloys; etc.
- 37. Photographic or Cinematographic Goods
- 38. Miscellareous Chemical Products
There are a similar set of qualifying production process rules for Section VII of the HS (Plastics and Articles Thereof; Rubber and Articles Thereof; Chapters 39 and 40)
4. Disassembled Goods, Parts, etc.
This category of PSRO occurs infrequently in practice. It provides a minimum regional value content test (60% of transaction value or 50% of net cost) for
- a good classified as an assembled good under rule 2(a) of the General Rules of Interpretation of the HS that was imported in an unassembled or disassembled form, or
- a good where one or more of the non-originating materials classified as parts under the HS cannot satisfy the tariff shift requirements because both the good and the materials are classified in the same subheading (or the same heading that is not further subdivided into subheadings).
For example, assume that leather jackets are imported into Mexico from Brazil in disassembled form; i.e., the sleeves, back and two sides of the front are separate. The Mexican manufacturer assembles the jackets and adds cresting, ornaments and other specialized finishing requested by a motorcycle club in the United States. Following rule 2(a), the disassembled parts would be classified together in subheading 4203.00 as a leather jacket. Since this is the same classification as the finished jacket, and the 10% de minimis rule would not apply, the finished jacket would not originate under the PSROs in Article 4.2(b). However, it would originate under Article 4.2(d) if the regional value content exceeded 60% under the transaction value method or 50% under the net cost method.
This category may not be used for goods of the following Chapters:
- 61. Articles of apparel and clothing accessories, knitted or crocheted
- 62. Articles of apparel and clothing accessories, not knitted or crocheted
- 63. Other made up textile articles; worn clothing and worn textile articles; rags.
Fungible materials are materials that are interchangeable for commercial purposes and the properties of which are essentially identical. Examples include specific grades of grain, crude oils of similar quality and viscosity, natural gas suitable for transmission in a pipeline nd gasoline.
A producer who uses a combination of originating and non-originating fungible materials to produce a good has several options in deciding how to account for them in determining whether the good originates. The most direct is to keep the two categories physically separate, or to keep them together and mark the individual items separately. However, neither of these options will be practical or cost effective in most circumstances.
The more practical alternative is generally to commingle the fungible materials without marking them and use one of the prescribed inventory management systems adapted from generally accepted accounting principles. These systems are FIFO (first-in, first-out), LIFO (last-in, first out) and the average method. All three use inventory accounting records to determine the origin of commingled fungible materials drawn from inventory. The details of applying each method are found in [Section X] of the Uniform Regulations.
A producer who produces both originating and non-originating fungible goods and sells them together in commingled form has the same options as described above for fungible materials.