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Trade Risks (Part 3): Trade Preference Programs 

by Janet Labuda

In recent hearings on Capitol Hill, Peter Navarro of the National Trade Council talked about the need for free, fair, and reciprocal trade agreements. According to Secretary of Commerce, Wilbur Ross, the United States, Canada, and Mexico will engage in discussions to modernize the North American Free Trade Agreement starting in early summer.

As we all know, the United States canceled its participation in the multi-lateral Trans-Pacific Partnership agreement, stating that any new agreements would most likely be bi-lateral in nature. Regardless of how the state of play turns out, the ability to administer, monitor, and enforce these agreements will be crucial to their success.

Currently, the United States has free trade agreements with twenty countries. In addition, there are legislative initiatives such as the African Growth and Opportunity Act,  the Caribbean Basin Initiative, and the Haiti HOPE Act that are meant to provide an economic stimulus to the foreign countries involved, if certain conditions are met.

There are two rules of origin that enter into the trade process, one for non-preferential treatment, and one for preferential treatment of goods. What is basic to the use of any preferential agreement is the description of the product to enable an accurate classification in the Harmonized Tariff Schedule. The classification, linked to the country of origin, will be key to meeting the requirements or conditions necessary to claim a benefit under a preferential trade program. It should be noted that origin, or where the product was made, as opposed to where the product was purchased or obtained is what drives preference.

In general, legislative trade programs tend to have easier preference requirements compared to negotiated Free Trade Agreements (FTAs). Most FTAs contain similar origin requirements which include:

  • Employing the “wholly obtained” criterion for goods that are wholly the growth, product, or manufacture of a particular country. On the other hand, for goods that consist in whole or in part of materials from more than one country, the majority of U.S. preferential rules of origin schemes are based:
    • on a change in name, character, and use (substantial transformation) and
    • on a required minimum local value content; unless specified otherwise, the cost of foreign materials may not be included in local value content unless they undergo a double substantial transformation.
  • Other preferential rules of origin (e.g., NAFTA preferential rules of origin) are based on a tariff-shift method and/or regional value-content method for goods that are not wholly obtained from the applicable region or country.

Therefore knowledge of the origin of various components will be key to obtaining preferential treatment.

One of the more complex rules involves the manufacturing of wearing apparel. While many exceptions can be negotiated, the basic rule for textile imports claiming preference include a yarn forward rule of origin. This means that the yarn must originate in a partner country, the downstream fabric production must be originating in a partner country, and the assembly must occur in a partner country.

It does not matter which rule of origin you are claiming or for what product. What matters is that everyone in the supply chain understands the conditions of preference and possesses documentary evidence supporting the preferential claim of reduced, or duty free, treatment. It is imperative that all participants in the supply chain know that a claim of preference under a special trade rule will be made.  Each participant in the supply chain needs to understand what documents are required to show production, to support the claim. Enforcement of trade preference programs is complex; traditionally non-compliance has often exceeded 20% of claims reviewed.  In most instances the participants in the supply chain failed to maintain adequate records.

It is recommended that for every product for which a preference will be claimed, a manufacturing log be created and updated as any changes to the production occurs.  Begin with the purchase order that provides an in-depth description of the final product. Identify components used and their origin.  Describe each step of the manufacturing process, and maintain backup documents showing the process from beginning to end.  This will go a long way in effectively dealing with Customs inquiries as both Congress and the Administration are calling for stepped up enforcement of U.S. trade laws.