Determining Eligibility for Free Trade Agreement Benefits
According to research conducted by Thompson-Reuters, only about 30 percent of U.S. businesses that export take full advantage of FTAs, and when asked why, the overwhelming majority noted the complexity of determining eligibility and meeting compliance requirements.
But given the potential opportunities, it may be well worth an exporter’s time to understand how to determine if its products meet FTA eligibility requirements. While no two FTAs are the same, all 14 include specific “rules” that set out the precise terms of the agreement.
Those rules, officially called rules of origin (ROO), detail criteria for determining the country of origin for a specific product and set specific requirements for trade benefit eligibility. Rules of origin define an FTA’s standards for “origination” and establish benchmarks for meeting those standards. Each trade agreement’s ROOs are unique to that agreement, and a business should not assume that eligibility requirements that suffice for one FTA will be sufficient for another.
In general, a business must be able to demonstrate that its product was partially or wholly manufactured in an FTA-partner country and that it is comprised of materials either “wholly” from the FTA region or includes a percentage of components from non-FTA countries (called non-originating goods) that fall within the scope outlined in the FTA. Each agreement also provides for non-originating goods that undergo “substantial transformation” during the production process.
Substantial transformation is a critically important concept since, depending on the FTA, a product may include certain percentages of non-FTA materials and still qualify for benefits. The party seeking FTA benefits will have to show that those component parts were significantly changed during the manufacturing process and resulted in a new article. This typically means having to prove there is a change in name, character, or use, or that there has been a change in tariff classification. This change in tariff classification is called a “tariff shift.”
Another important consideration is the “de minimis rule.” As explained by the International Trade Administration, the de minimis rule allows up to 10 percent (7 percent under USMCA) of the selling price to be based on qualified non-qualifying material, even if that material does not meet the tariff shift test.
Each set of ROOs includes multiple chapters, with each chapter outlining eligibility requirements for a particular category of goods. For example, in the U.S.-Australia agreement, tariffs on qualified U.S. textile, apparel, and footwear goods entering Australia have been eliminated. In general, this applies to goods containing only U.S. or Australian inputs. However, goods containing inputs from other countries may still qualify if they meet specific criteria set out in “Annex 4A” to the Textiles and Apparel chapter of the agreement’s ROOs.
Once Annex 4A is accessed, a user will notice that all “discussion” is tied directly to tariff classification codes. Each product has a unique rule, based on its tariff classification, which underscores the critical importance of assigning the correct Harmonized System (HS) tariff classification code.
Assigning the Correct Classification Code
As described by the International Trade Administration, the Harmonized System (HS) is an international classification system standardized between countries. The international HS categorizes products by 6-digit codes. Countries then supplement the HS with additional digits that are unique to that country. In the United States, the Harmonized Tariff Schedule of the United States assigns 10-digit codes to each product using the HS’s 6-digit code as the “root.”
The HS classification number is then used to identify the corresponding tariff rate and to determine if the product is eligible for FTA benefits.
By CBP’s own admission, determining a product’s correct classification can be a highly confusing endeavor. Differences between classification categories can be slight but can trigger vastly different tariff obligations. Great care must be exercised, and an importer must avail itself of a number of tools designed to facilitate the process:
- HTS General Notes. The Harmonized Tariff Schedule includes detailed notes and guidance, in the form of “General Rules of Interpretation,” that accompany each HTS chapter. One industry expert, John Goodrich, refers to the Rules of Interpretation as the “instructions” for determining the correct classification code. “You search the HTS until you find its specific classification,” Goodrich wrote. “You can also eliminate all of the other classifications until you are left with nothing but the parts classification.”
- Online “Tariff Lookup Tools.” These are available for both U.S. importers and exporters. The International Trade Commission offers an online database for importers, and the U.S. Census Bureau maintains a Schedule B lookup tool through which Schedule B export codes can be identified. Keep in mind that a database match does not guarantee a correct classification but is only intended to offer guidance.
- Advance Rulings. To eliminate uncertainty about a product’s tariff classification, a business may request a binding “advance ruling” from CBP. In fact, CBP’s website states: “The U.S. Customs Service strongly urges all parties engaged in transactions relating to the importation of goods into the United States to obtain binding advice from the U.S. Customs Service prior to undertaking that transaction.”
Once the HS number has been identified, a business can then consult a free trade agreement’s ROOs to determine if a product meets eligibility requirements.
FTA Eligibility Checklist
To help determine FTA eligibility, CBP offers a “checklist” to clarify requirements. Among the checklist items:
- Is your good dutiable upon importation into the United States or an FTA-partner country? If not, it may not be worthwhile for you to perform a free trade agreement origination analysis and adhere to the recordkeeping requirements necessary to making an FTA claim.
- Do you know your goods background? Where was it grown, mined, or manufactured? Do you know where the components or ingredients were produced? If the answer is “no,” do not claim preference.
- Was your good produced in an FTA-partner country or was it produced elsewhere and merely shipped through or subject to minor processing in the FTA partner? If the good was not SUBSTANTIALLY manufactured in an FTA country, do not claim FTA preference!
- If your good was produced in an FTA-partner country, do you have a certificate of origin or affidavit from the EXPORTER or MANUFACTURER attesting that it “ORIGINATES” under the terms of the FTA? If the answer is “no,” do not claim preference.
- If you have an affidavit or certification of origin from the exporter or producer in the FTA-partner country, is the Harmonized System (HS) number correct? Is the signatory someone in the company with knowledge of how the good was produced and access to substantiating records? Is it plausible that this type of product was produced in this country? If the answer to all three questions is not “yes,” do not claim FTA preference.
- Subsequent to the good’s production, did it enter into the commerce of another country? If the answer is “yes,” do not claim FTA preference. (Disregard this question with respect to goods of Australia, Bahrain, Chile, Morocco, Oman, or Singapore.)
- Subsequent to the good’s manufacture, did it undergo operations outside of an FTA-partner country other than to unload, load, or preserve it in good condition? If the answer is “yes,” do not claim FTA preference.
- Do you have any reason to suspect the veracity of the documents provided to you? If “yes” and you proceed to make a claim, you would not be exercising your reasonable care responsibilities.
- Is EVERY molecule of your good, including all of its components (from resource extraction through the entire chain of production), the product or growth of the U.S. or an FTA-partner country, and have you records to that effect? If “yes,” your good is “wholly obtained” and preference can be claimed.
- Is your good made EXCLUSIVELY from materials produced in the United States or an FTA-partner country and for which you have a certificate of origin of the manufacturer’s affidavit on file? If “yes,” your good is “exclusively of originating materials” and preference can be claimed.
Assistance with Determining Free Trade Agreement Eligibility
Businesses can avail themselves of any number of public and private resources for assistance in determining eligibility. A good place to start is with the International Trade Administration’s FTA Tariff Tool, which incorporates all Harmonized System classification codes and indicates the tariff obligation of each code under each U.S. free trade agreement.
The Customs Border Protection agency maintains a network of 10 different “Centers of Excellence and Expertise,” with each center dedicated to oversight of a particular industry. The Centers are “virtually” staffed by subject experts who are available to assist members of the trade community in preparing shipments.
A business can also find direction via Export.gov, which is the entry point for all government trade services.
Or, for more immediate assistance, a business can enlist the services of a qualified customs broker or logistics provider that will have in-depth knowledge of all applicable trade agreements and also be able to assist in documentation preparation and filing.
Documentation and Recordkeeping Requirements
Once a product is determined to be eligible for FTA benefits, the next step is to document eligibility and to comply with all documentation and paperwork requirements.
Certificate of Origin
For many – but not all – FTAs, the “certificate of origin” is a critical piece of documentation. As defined by the International Chamber of Commerce, a certificate of origin is a trade document that “certifies that goods in a particular export shipment are wholly obtained, produced, manufactured, or processed in a particular country. They also serve as a declaration by the exporter.” But certificates of origin can come in many forms, so a business needs to carefully review the requirements of the FTA for which benefits are being sought.
USMCA, for example, requires a specific “USMCA Certificate of Origin.” Other agreements require specific data sets, but the information can be included on a company’s letterhead or via a certificate of origin “template” accessible through the U.S. Export.gov trade portal.
In some instances, Korea and Jordan for example, importers can use alternate methods of documenting product origination, including a manufacturer’s affidavit, free form certification, commercial invoices, or notarized receipts. Minimum elements that must be provided generally include:
- Name and contact information of the importer
- Name and contact information of the exporter
- Name and contact information of the production
- Tariff classification number and description of the product
- Statement about how a particular product “originates,” including how it complies with particular rules of origin where applicable (Some agreements use a code system for this information, where others accept written sentences explaining how a particular good qualifies for an FTA [e.g., Australia].)
Requirements also vary with regard to which party has responsibility for providing documentation. According to Export.gov, USMCA and the FTAs with Israel and Jordan require the exporter to complete the certificate of origin. FTAs with Australia, the CAFTA-DR, Chile, and Morocco give that responsibility to the importer.
A business can learn about a specific FTA’s documentation requirements by accessing Export.gov.
Additional Documentation Needed for FTA Eligibility
Beyond the certificate of origin, an exporter will need to provide additional documentation. While specific requirements will vary based on the destination country and shipment contents, common export documents, as described by the International Trade Administration, include:
- Commercial Invoice. The commercial invoice is a bill for the goods from the seller to the buyer. These invoices are often used by governments to determine the true value of goods when assessing customs duties.
- Export Packing List. This document includes more detail and information than a standard domestic packing list, including the seller, buyer, shipper, invoice number, date of shipment, mode of transport, carrier and itemized quantity, description, type of package (i.e., box, crate, drum), quantity of packages, total net and gross weight, and package dimensions. The export packing list is not a substitute for the commercial invoice.
- Pro Forma Invoice. This is an invoice prepared by the exporter before shipping the goods. The pro forma invoice alerts the buyer of the goods to be sent, their value, and other key specifications.
- Airway Bill. This bill is specific to air freight shipments.
- Bill of Lading. This is a contract between the owner of the goods and the carrier.
- Electronic Export Information (EEI). This is the most common of all export control documents. It is required for shipments valued at more than $2,500 and for shipments of any value requiring an export license. The EEI must be filed electronically. (Shipments to Canada do not require an EEI unless and export license is required. Shipments to third countries passing through Canada do need an EEI.)
- Export License. This is a government document that authorizes the export of specific goods in specific quantities to a particular country. Generally, this is only required under special circumstances, including for exports to certain countries or products including defense-related materials or controlled substances.
Additional documentation may be required depending on shipment contents and destination, so it is very important for a shipper to carefully review documentation requirements when preparing a shipment for export. Many businesses choose to enlist the services of an experienced customs broker or logistics provider to manage this important function on their behalf, since incorrect documentation is a leading cause for shipments to be delayed at the border.
Each free trade agreement includes specific requirements with regard to proper recordkeeping, including the length of the retention period and the types of documents that must be maintained. Exporters should understand that proper recordkeeping is part of “the deal” when seeking FTA benefits but also that FTA benefits come with an increased risk of an audit. In short, the government has an interest in ensuring that parties to whom it provides benefits have followed all FTA protocols and can produce documentation to back up all claims. In most cases that means being able to provide documentation for as long as five years after an FTA claim has been submitted.
Failure to maintain documents for a required period of time could result in fines and a loss of exporting privileges.
Denial of Benefits
In some instances, a partner country may choose to deny FTA benefits for failure to comply with its customs regulations. According to CBP, examples that may result in denial of benefits include:
- Failure to provide a certificate of origin that meets the specific terms of the FTA or when there are reasonable grounds for believing there may be efforts afoot to evade the certificate of origin requirement.
- Failure by the person who signed a certificate of origin to consent in writing to a verification visit during the 30 days after notice of an intent to conduct such a visit is sent.
FTAs Are Voluntary – Choose Your Partners Wisely
Since the decision to seek FTA benefits is voluntary, a business must prepare for two contingencies:
- Suppliers are not required to produce required FTA documentation. Any business that must rely on a third party to document eligibility, which usually occurs via a manufacturer’s affidavit or a certificate of origin, must ensure the third party’s willingness to do so ahead of time. For various reasons, a third party may be reluctant to commit the time or resources necessary to assist in your documentation process, especially if the third party does not participate in the FTA process.
- Not every logistics provider prioritizes FTA benefits. Since complying with required customs mandates can be time-consuming and complicated, not all logistics providers are willing to commit additional resources to help businesses identify potential FTA opportunities. This, of course, is a tremendous disservice but can be avoided if a business takes the time to proactively ensure that a logistics provider has a high level of competency with the customs process and will seamlessly take the extra step to identify opportunities to achieve savings.
On the day the new United States-Mexico- Canada Agreement (USMCA) was announced, Jim O’Sullivan, an economist with High Frequency Economics, expressed to CNBC his expectation that the agreement “would go from being one of the worst deals ever to one of the best.”
The new agreement which, if approved by the U.S. Congress and by the Canadian and Mexican legislatures, will replace the North American Free Trade Agreement, entered into in 1994. It has been regarded as the most consequential of the 14 free trade agreements the U.S. currently has in effect.
But despite all the media attention the new agreement has received, an important fact generally goes unsaid: Although 95 percent of the world’s consumers live outside of the U.S., fewer than 1 percent of eligible businesses export.
Reasons for this vary, but top explanations include the complexity of the compliance process, an assumption that a company’s products won’t qualify, limited resources to expend on compliance, and a general unawareness of how to initiate the process.
Take Advantage of FTA Benefits with Purolator International
The bottom line, though, is businesses are leaving money on the table and missing out on opportunities to increase sales and expand their customer bases.
With multiple resources available to help, an interested business can usually find the process quite manageable. With everything to gain, savvy businesses will come to understand – and take advantage of – the tremendous opportunities offered through a free trade agreement.
To learn more about FTA eligibility and how Purolator International can help you take advantage of FTA benefits, contact us today.