U.S. Customs (U.S. CBP) rulings over the past two years reveal the unexpected impact of “Section 301” tariffs on Chinese products with respect to goods assembled in Canada or Mexico and that are imported into the United States. A contradiction can arise when a product, which is recognized as having a country of origin that is a member of the North American Free Trade Agreement (e.g., Canada), under the NAFTA preferential rules, while remaining a product of Chinese origin within the meaning of the U.S. rules of origin for non-preferential countries of origin, could also be subject to additional tariffs on Chinese products (Section 301 Tariffs).
For the products they import into the United States, businesses must closely examine the determination of the country of origin of their products to ensure that they fully understand their obligations in terms of duties, safeguard tariffs and country of origin markings to avoid unforeseen penalties and/or additional tariff assessments.
This article provides an overview of the “non-preferential” rules of origin and “preferential” rules of origin, using the NAFTA rules of origin as an example. We will also look at the scenario in which a product, considered “originating” under NAFTA, may also be found as originating from China, which may result in additional tariffs being applied to imports into the United States.
The determination of the country of origin and the appropriate marking of the product are compliance elements that are regularly subjected to audits by customs. In the United States, importers are required to ensure that the product is properly marked and/or labelled and to declare the correct country of origin for each imported article. Also, the regulations requires the importer to exercise reasonable care when importing; specifically, the regulations require the importer to ensure that the information is reported in a manner that properly assesses duties and taxes, and that all other legal obligations applicable to the importation are met. These provisions are particularly relevant in the current context where additional safeguard tariffs (under the Trump administration) are charged based on country of origin, such as the tariffs on Chinese products.
A misrepresentation of the country of origin may result in the imposition of a penalty of a variable amount based on the degree of negligence involved. Such errors can lead to damages, detention or exclusion of goods at the time of import or even seizure by the U.S. CBP. In addition, if U.S. Customs determines that the goods are not properly marked with the correct country of origin and in accordance with applicable marking regulations, a penalty equivalent to 10% of the value of the good may be applied in addition to other duties and surcharges. For many reasons, it is incumbent on the importer to determine the correct country of origin, whether for marking, NAFTA preference or the applicability of “Section 301” tariffs.
I. Non-preferential rules of origin
A. Entirely grown, produced or manufactured
The non-preferential rules of origin follow the marking provisions of Regulation 19 C.F.R. Part 134. The simplest method for determining the country of origin is when the product is either an animal, mineral or vegetable product that was raised, extracted or harvested in a single country, and where the product is manufactured/produced in a single country with only components from that country.
Section § 134.1 provides that the “country of origin” is the country of manufacture, production or growth of any article of foreign origin entering the United States. However, if the product does not originate entirely from a single country, the country of origin of the imported product must then be assessed using the “substantial transformation” test.
B. “Substantial transformation” test
If the origin cannot be determined by applying the “entirely grown, produced or manufactured” test in Part A above and the merchandise contains inputs, materials and/or components from various countries of origin, the country of origin, for U.S. Customs purposes, is the country in which a “substantial transformation” is carried out.
For the required transformation to occur, a product must have a new name, character or other use, separate from the materials used to produce it. The “substantial transformation” test relies on several factors, meaning that no factor is decisive in determining the origin.
Among the key factors, the U.S. CBP considers the following:
- The complexity of the manufacturing or assembly process.
- The number of hours of work required to perform the manufacture or assembly, and the level of skill and training required by the workers to perform the work.
- Whether complex and sophisticated equipment is used in the manufacturing or assembly process.
- The number of separate steps required to complete the manufacture or assembly.
- The cost of labour and materials used in the manufacture or assembly in North America, in comparison with the overall cost of labour and materials used in all countries for the complete manufacture and assembly of the finished product (i.e. local value added).
- If individual components of Chinese origin lose their individual identity during the manufacture or assembly process, and if these individual components were functional devices before being subjected to further manufacture or assembly in North America.
- If the components imported from China undergo a change in tariff classification when they are manufactured or assembled in relation to the tariff classification of the finished product.
- If the essential character of the finished product is imparted by the manufacture/assembly process in North America or if the essential character of the finished product is imparted by the components or materials imported from China.
For U.S. Customs to recognize a change in character, there often has to be a substantial change in the characteristics of the components. Changes of a purely cosmetic nature are not enough to conclude that there is a “substantial transformation.” Furthermore, change of name alone is not a decisive factor. The “substantial transformation” test is nuanced. As a result, the U.S. CBP analysis is done on a case-by-case basis, often involving subjective judgements as to what is admissible, contrary to the preferential rules of origin, such as NAFTA, which are more objective.
A misunderstanding can occur when an importer believes that there has been a change in the tariff classification of components in comparison with the classification of the finished product (see item no. 7 above), and the importer automatically assumes that a “substantial transformation” has occurred. While the change in tariff classification is one of the elements that may imply a “substantial transformation,” it is not the only rule and consideration. Even if a change in tariff classification occurs, the factors listed above must be examined as a whole to determine whether a “substantial transformation” has actually occurred.
U.S. CBP tends to focus on the change of use or character of constituent materials after further processing and/or assembly into the finished product. However, the importer must exercise caution when assessing whether the assembly results in a “substantial transformation.” In the case of assembly of imported components, U.S. jurisprudence shows that the courts and CBP are reluctant to find a change in character, in particular when imported articles do not undergo a physical change or transformation on their own.
In this regard, the relevant criterion is to specify the extent of the assembly (e.g. made in Canada) and to determine whether the components lose their identity and become an integral part of an entirely new article. That said, a simple assembly of goods that only takes a few minutes, often does not result in the required transformation.
II. NAFTA rules of origin
Preferential rules of origin are used to determine whether the products qualify for special treatment, generally duty-free. In the United States, NAFTA eliminates tariffs on products considered to be originating in Canada or Mexico under its specific rules.
NAFTA country of origin marking rules (19 C.F.R. Part 102) generally use the change of tariff classification method (tariff shift) to determine the NAFTA country of origin for products that are not entirely obtained from a member country. Some products may also be subject to a NAFTA content calculation (Regional Value Content of the product).
Section 102.11 outlines the hierarchy to determine the country of origin of a product for marking purposes. The regulation states that, for purposes of NAFTA marking and determining the origin, the country of origin of a product is the country in which:
(1) the product has been wholly obtained or produced; or
(2) the product is produced exclusively from domestic materials; or
If none of the above applies, there are alternative methods for determining the NAFTA country of origin. For example, NAFTA origin can be determined based on the component that imparts the essential character to a product. If the product is a set, mixture or composite good, each component may be examined and taken equally into consideration. Finally, if the origin of a good cannot be determined by applying any of the rules above, the country of origin of the good is the last NAFTA country in which the good has undergone production other than a simple assembly or otherthan minor processing. Some examples of simple assembly or minor processing are specifically listed in the regulation (See 19 C.F.R. § 102.1(m) and 19 C.F.R. § 102.1(o), respectively).
It is important to note that the NAFTA rules of origin, for purposes of determining “originating” status, under Section 19 C.F.R. Part 181, must also be reviewed in order to claim preferential treatment under NAFTA for a product imported into the United States. The specific rules for determining whether a product is of NAFTA origin are listed in General Note 12 of the U.S. Customs Tariffs. (“HTSUS").
III. Unexpected applicability of safeguard tariffs on Chinese products “Section 301” for products assembled in a NAFTA country (CA or MX)
A business that imports NAFTA products into the United States must be aware of the potential applicability of tariffs on Chinese products, even if the product may be of NAFTA origin. This potential inconsistency arises from the various tests required to determine the country of origin, as defined in Sections 102 and 134 of the U.S. Code of Federal Regulations.
Even if the two regulations exemplify similar principles, they do not always have the same outcome because the NAFTA marking rules are objective, whereas the non-preferential origin criteria of the “substantial transformation” are rather subjective. In addition, the NAFTA marking rules set out in Section 102 only have a limited application for marking purposes and for determining the duty rate. At the same time, Section 134 must also be considered when determining the country of origin for the potential applicability of protectionist measures, such as “Section 301” tariffs.
Binding ruling H300226 of the U.S. CBP highlights this contradictory outcome concerning the determination of the country of origin of certain electric motors. A motor was assembled in Mexico using three components of Chinese origin. U.S. CBP determined that the motor was a Mexican product used for marking purposes under the NAFTA marking rules, but U.S. CBP also determined that the motor also had China as the country of origin under the “substantial transformation” test. Although the motor was qualified under NAFTA, it was still subject to the “Section 301” tariffs on Chinese products. U.S. CBP finds that when a product is subject to anti-dumping, countervailing duties or other U.S. safeguard measures (e.g., “Section 301” or “Section 232” tariffs), a “substantial transformation” analysis is required for determining the country of origin.
In the aforementioned ruling, U.S. Customs examined and determined that the name, character and use of the motor components had not been sufficiently modified to qualify as a “substantial transformation” and that the Mexican process was a simple assembly. In addition, the decision indicates that when the end-use of the components is predetermined at the time of import, the courts generally do not see a change in use. (See the C.I.T. ruling). In this case, the use of the imported motor parts had a predetermined end-use and the production process (in Mexico) was a simple assembly. As a result, no “substantial transformation” had occurred.
The main conclusion to be drawn is that, in examining the country of origin for the applicability of safeguard tariffs on Chinese products, the “substantial transformation” test must be carried out, even if the concerned product entering the United States comes from a NAFTA partner country (e.g. CA or MX). Businesses must understand that, when there is significant Chinese content in the finished product, even if the product may qualify under NAFTA rules, this does not mean that it will automatically be exempt from “Section 301” tariffs on Chinese products. The “substantial transformation” test according to Regulation 19 C.F.R. Part 134 is necessary, while taking into account the precedent set in the C.I.T. ruling upon which U.S. CBP often relies for the interpretation of this criteria. As a reference, you can also consult other rulings by U.S. CBP:
N302987 (one of the few rulings where “substantial transformation” is recognized by U.S. CBP)
Also, take note that the U.S. Government has begun to apply tariffs under “Section 301” on certain products from the European Union; in the coming days, a second wave of additional products originating from the EU will almost certainly be added to the list of products subject to surtax. In short, the same “substantial transformation” criteria under C.F.R. Section 134 will apply to determine the country of origin of the products for the purposes of these safeguard tariffs on European products. Even after the new CUSMA agreement (NAFTA 2.0) enters into force, if the tariffs under “Section 301” remain effective, an analysis of “substantial transformation” under Section 134 will still be required.
Businesses can mitigate the applicability of safeguard tariffs under “Section 301” by monitoring and by developing strategies for their production and assembly activities in Canada or Mexico to ensure that the finished product meets the criteria required in the “substantial transformation” test when Chinese (or European) inputs are used.
Businesses that previously imported Chinese products directly from China to the United States and who changed their supply chain to produce/assemble the product in Mexico or Canada (using Chinese components), in an attempt to avoid surtaxes on Chinese products under “Section 301,” are among the targets of U.S. CBP audits. More often than not, the “substantial transformation” evaluation is neglected, and U.S. Customs is aware of this lapse… Do not get caught off guard!
W2C offers several services to help you navigate the rules for determining country of origin, such as:
- customs training
- determining tariff classifications
- origin analyses based on any FTA (NAFTA, CUSMA, CETA, CPTPP, etc.),
- origin analyses for purposes of U.S. safeguard tariffs (e.g. Section 301)
- support during audits, recourse actions and corrections
- requests for rulings on origin,
- voluntary disclosures,
- and even more.
Contact W2C today to speak to one of our consultants.