By Michael Zobin
Canadian importers may soon have a new range of free trade options available to them in Asia. Ottawa has announced its intent to negotiate some degree of economic cooperation with the Association of Southeast Asian Nations (ASEAN), a group of 10 developing countries joined together to promote common interests and attract investment.
The announcement in November 2021 followed a similar move earlier in the year to negotiate free trade with Indonesia, Canada’s largest trading partner amongst the ASEAN. It’s all part of a broader initiative by Ottawa to diversify trade options in response to growing protectionist sentiment in the U.S.
While the move to diversify is laudable, it also presents importers with an expanding web of complexity, particularly as multilateral agreements begin to overlap. For example, Mexico is a member of the United States-Mexico-Canada Agreement (USMCA), but also a member of Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) involving 11 Pacific Rim countries. In theory, Canadian importers bringing in goods from Mexico could use either one of the agreements to leverage preferential duty rates, but in practice it may not be equally advantageous to do so. Similarly, four of the ASEAN countries are members of the CPTPP and almost all the ASEAN countries are members of the recently enacted Regional Comprehensive Economic Partnership (RCEP), a trade deal involving 15 countries in Asia-Pacific. But that does not mean Canadian importers can necessarily access the benefits of the RCEP the same way member countries can.
There are several factors importers must consider when evaluating how to make use of overlapping trade agreements. Careful evaluation could mean the difference between cost savings and streamlined supply chains vs. administrative headaches and cost overruns.
Evaluating the Tariff Advantage
Not all trade deals are created equal. While most trade deals have the core goal of reducing or eliminating tariff barriers, there are different ways this can be achieved. For example, there may be two trade agreements that both eliminate tariffs on the same good. However, one agreement may have a tariff-rate quota in place that would apply tariffs to the said good once a certain threshold has been exceeded. In other cases, tariffs may not necessarily be eliminated but dramatically reduced and not always to the same level.
The first and easiest step for an importer to take when evaluating which trade deal may be more advantageous is simply to look at the tariff status for the good being imported. If all is equal, then next step is evaluating the Rules of Origin.
Circumventing Administrative Burden
For the uninitiated, Rules of Origin are the rules that govern whether or not an imported good qualifies for preferential duty. In some cases, Rules of Origin can be simple and straightforward, requiring minimal analysis (i.e., tariff shift) allowing for proof of origin within the region associated with the trade agreement to be issued. In other cases, they can be far more onerous. Take, for example, the Rules of Origin associated with automobiles under the USMCA, which require a broad range of very specific requirements to be met in order to qualify for duty exemption. Automakers have to prove 75% of the vehicle was produced in North America; that 45% of the vehicle is made with laborers earning at least $16/hr; and (eventually) that 70% of the steel and aluminum content originates in North America.
Trade agreements offer varying degrees of compliance complexity. While the auto sector under the USMCA may an extreme example, there are variations in administrative burden across trade deals and many importers may choose to take advantage of a trade agreement for which the Rules of Origin require greater ease of compliance. However, the ease of administration must be balanced against the originating criteria.
Moving goods across multiple borders
Given the overlapping nature of the CPTPP, an ASEAN trade deal and the RCEP, one might presume that moving goods from a non-CPTPP or non-ASEAN country within the RCEP to a country within the ASEAN bloc or CPTPP, and then further moving those goods into Canada would be acceptable. But it probably will not be.
The key is understanding the originating requirements for the product. The Rules of Origin will require the product to undergo a certain degree of transformation during the transshipment process in order to qualify for preferential duty when it arrives in Canada. For example, moving a consumer electronic product produced mostly in China to Vietnam (a member of the CPTPP and the ASEAN) for minor modification and final assembly may be insufficient to qualify for duty exemption under the CPTPP or a future trade deal with the ASEAN. The importer would have to provide certification from the exporter that the product meets the requirements for adhering to the rules of origin, which can include tariff shift and regional value content analysis by showing that, in the case of regional value content, a minimum percentage of the product was produced in Vietnam (and/or another CPTPP country) in order to receive duty exemption.
The issue of transshipment and Rules of Origin is equally important for Canadian importers who bring in intermediate or partially finished goods for production and assembly in Canada before re-exporting to the U.S. While Canada and the U.S. are both members of the USMCA, that doesn’t mean goods produced mostly in a CPTPP country can flow through Canada into the U.S. without significant alteration. The USMCA’s rules of origin would require significant alteration of the product to take place in order for there to be a tariff shift and possibly a regional value calculation that would qualify for preferential duty under the USMCA. Leveraging the CPTPP for preferential duty on intermediate goods imported from Asia before re-exporting to the U.S. may not be advantageous if significant alteration is not taking place in Canada, as it could preclude a U.S. importer from taking advantage of preferential duty under USMCA, in turn, making the Canadian exporter’s product less competitive. Importers must carefully investigate the specific requirements for Rules of Origin in order to determine which free trade agreement is most advantageous, or how they might make use of both agreements.
Transport Routes a Key Consideration
How goods move to their final destination is also a critical point for importers to consider when deciding which trade agreement to use. For example, a Canadian importer could use the CPTPP to import goods from Mexico. If the good is being transported by sea directly from Mexico to Canada, there could be a reason to use the CPTPP. But most likely goods moving between Mexico and Canada are being moved by ground transport through the U.S. If the importer uses the USMCA to move the goods, they will only need to certify the goods one time as the certification would apply to the U.S. and Canada. Otherwise, they would have to certify the goods under the USMCA for entry into the U.S. and lose the CPTPP preferential privileges for entry into Canada as the goods were not shipped directly from one CPTPP country to another (USA is not a part of the CPTPP). Alternatively, the goods could be transferred from Mexico to Canada in-bond through the U.S.
Canadian importers who are also non-resident importers in the U.S. and ship goods from Asia to U.S. ports before dividing the cargo via land transport to separate Canadian and U.S. destinations should be mindful that leveraging the CPTPP for the goods entering Canada (transported in-bond across the U.S.) while paying Most-Favored Nation rates in the U.S. isn’t likely to result in cost savings. It may be more advantageous to create separate shipments to Canada and the U.S.
Know the Rules
Understanding the Rules of Origin and how to properly comply with them is no easy feat for any business. Trade deals are often hundreds of pages long and require a strong understanding of the nuances of trade rules, something few business owners and managers possess. Attempting to make sense of the Rules of Origin for one trade agreement (and how they intersect with transport routes) is incredibly challenging but doing so across multiple agreements and making cross comparisons can be outright vexing.
Businesses looking to optimize their use of multilateral trade deals will want to consult with experts in the field, such as trade consultants, trade attorneys and logistical experts to identify not only where cost savings may exist, but also where hidden risks may lurk that could result in punitive measures from government entities or administrative burden that overwhelms an organization’s human resources.
Michael Zobin is a Canada-based director of global trade consulting at Livingston International. His expertise includes supply-chain optimization; duty deferral and drawbacks; conducting compliance program reviews; developing compliance procedures; voluntary disclosure; and post-entry review.