Australia-China FTA Conference in Shenzhen

28-29 June 2006

Day 2: Rules of Origin

AUSTRALIAN CUSTOMS SERVICE'S EXPERIENCES

Mr Andrew Rice, National Manager, Trade Measures Branch, Australian Customs Service

RULES OF ORIGIN

According to the Kyoto Convention, a commodity that combines materials or processes from two or more countries will be considered the product of the country in which it was last subjected to a substantial transformation.

A transformation is ‘substantial' when it yields a commodity which is ‘new and different' from the commodity that entered the transforming process.

There are three principal methods for determining origin and asserting the "substantial transformation" process:

value-added criteria;
product-specific (technical or production) process; and
change in tariff classification.

Value-added method

This method is a popular way for determining origin eligibility for goods.

The value-added criterion is sometimes called percentage criteria. Using this method of Rule of origin (ROO) determination, a certain percentage of value needs to be added to the imported non-originating materials, in the exporting partner of the Free Trade Agreement (FTA), to confer origin on the final product.

The criterion itself can be expressed in at least three forms, and these are comprehensively addressed in the paper prepared by Peter Lloyd and Donald MacLaren from the University of Melbourne.

Once this certain "value-added" amount is measured, it can be compared with a specific percentage parameter (ie, the bench-mark regional content established by the ROO). If the measured local content of the product meets this parameter, it is considered to be originating in the territory and therefore eligible for the preferential treatment.

The value added criterion may be employed as the sole method of determining ROO or may be used in conjunction with other methods.

Value-added may be stated in a transparent and objective way. But value added may be more certain in its statement than its application. Calculation of value-added frequently depends upon complex accounting issues that can raise considerable uncertainty. Uncertainty resulting from the use of value-added methodology happens because origin is never finally determined until audits are completed, a process that can take years. If the auditors disagree with the calculations of the parties involved, enormous and unexpected demands for payment of duties may result.

The dependence on such accounting issues leads to another disadvantage of the value-added method, namely the need for lengthy and costly audits to verify value-added claims as it is also necessary to carry out audits after the event to certify the costs of work carried out. This may make the value added system expensive to apply.

Further, under the value-added method, origin may change in unpredictable or unusual ways. The same operations in the same facility may confer origin and may not, depending on the fluctuations in exchange rates and/or material and labour costs. Operations that will confer origin in one country may not do so in another because of different labour costs.

Production specific (technical) process method

The specific production process rule is sometimes referred to as the technical or process requirement. Under this methodology, ROO are drawn in terms of concrete industrial operations. In other words, to determine origin is to specify that "substantial transformation" has occurred when a specific production process has been carried out.

This test explicitly specifies production or sourcing processes that may (positive test) or
may not (negative test) confer originating status.

This test amounts to specifying a technical definition of substantial transformation and therefore is sometimes referred to as "technical test".

The system has the advantages of transparency, predictability, and less subjectivity. Moreover, it is the least costly method of determining origin. However, it suffers from a number of disadvantages, the most important of which is obsolescence, as technical developments may tend to overtake the texts of specific rules.

To have a comprehensive product specific process encompassing all the products traded internationally is likely to be impossible, due to the huge variety of products traded and the various as well as changing production techniques used in their production. Thus, specific process of production has some serious limitations that deprive its use as a major method applied in practice. Nevertheless, it is applied either alone or, more often, as a supplementary method used in conjunction with other methods for determining ROO and in particular with Change in Tariff Classification (CTC).

Change in Tariff Classification method

The CTC method, sometimes but incorrectly called the Change in Tariff Heading Rule, relies on the imported inputs used in the production of a good undergoing a change in tariff classification within the territories of the exporting partner of a FTA. If this occurs the goods are considered to be originating in the exporter country.

The basic notion underlying this approach is that, for most goods, a reasonable way to measure the degree to which an imported input is transformed within the territory is to compare the tariff classification under which it was imported with the tariff classification under which the final product would be exported. If these two tariff classifications are sufficiently "distant", in the sense that they apply to substantially different goods, origin can be attributed.

CTC confers origin if the manufacturing process results in a product that falls under a Harmonized System (HS) number that is different from the number under which the non-originating (ie imported) inputs or materials fall.

There are many advantages of utilising a CTC ROO methodology and these are addressed later in this paper. Conversely, there are some shortcomings in using this methodology, including the fact that the tariff schedules were not designed with origin determinations in mind.

Use of different ROO methodologies

In practice, the ROO for most FTAs incorporate a hybrid of methodologies. Australia's most recent FTAs, those with the United States and with Thailand, are CTC based but some tariff classifications also incorporate either a regional value content requirement or a form of specific process of production requirement.

This facility is commonly utilised in respect of sensitive commodities where certain levels of local production beyond a change in tariff classification might be required.

Methodologies employed in Australia's FTAs

Australia's FTAs with the United States and with Thailand principally rely on the CTC methodology for the determination of origin.

In a number of instances the product-specific ROO in these FTAs combine a CTC requirement with a regional value content (RVC) requirement or with a specific process of production requirement (technical test). The RVC requirement is by far the most widely used "second requirement" in these FTAs.

Australia's FTA with New Zealand currently relies on the value-added method of determining origin. This FTA has a base requirement of local content of 50%, which can be varied to 48% in exceptional circumstances. This FTA is presently in the process of being changed to a CTC basis.

Australia's FTA with Singapore relies on the value-added methodology and has a basis local content requirement of 50%. There are some variations to this requirement within the FTA that take account of manufacturing circumstances within the territory of the two FTA partners.

Australia's experience with CTC

Australia utilises the CTC methodology in two of its FTAs.

Australian importers, exporters and administrators have found that the CTC methodology is a transparent, predictable and objective means of determining the origin eligibility of goods.

Record keeping by importers and exporters is kept simple with the CTC ROO because the act of importing a good into a customs territory automatically generates a documented record of origin that includes a tariff classification. Consequently, reliable record keeping is undertaken for non-originating materials and thus if required to produce evidence, the manufacturer will normally have no difficulty in furnishing data establishing that the goods do in fact meet the ROO.

The CTC methodology is also easy for administrators to apply due to the document trail available in respect of non-originating production inputs. Additionally, where a RVC element is combined with the CTC requirement, the values required to undertake the RVC calculation, normally the Free On Board (FOB) or Cost, Insurance and Freight (CIF) are readily available.

Australia's CTC Rules and their acceptance

The product-specific ROO utilised in the AUSFTA and the TAFTA provides a rule in respect of each subheading of the HS. In many instances, where the same requirement is specified for a number of subheadings or headings, the ROO is applied to that range of subheadings/headings.

As stated, in some instances the CTC rule is supplemented by a regional value content rule, and in other instances it may be supplemented, or replaced, by a process (or technical test) rule

The particular product-specific rules are presented in specifically written Regulations, rather than an Act of Parliament as this option allows for easier amendment such as what is necessitated by HS changes dictated by HS 2007 changes.

While some of Customs' clients were overwhelmed when presented with the ROO implementing the AUSFTA and the TAFTA some 18 months ago, they quickly and easily adapted to this type of ROO. The number of enquiries made to Customs has rapidly declined and now rarely occur.

Certainly, the Australian Customs Service, which administers the rules and the eligibility of imported goods to claim preferential rates of duty, strongly favours this type of ROO over the traditional value-added methodology. Customs officers have found the determination of correct origin status less burdensome and more objective than the traditional ROO methodologies.

Summary

While the ease of implementation and operation of the ROO model adopted for any trading arrangement are considerations for administrators and traders, the costs and advantages and disadvantages for both groups must be considered.

The costs / benefits of the two main ROO methods, value-added and CTC, can be summarised thus:

costs are very similar during the negotiation stage;
costs are less for value-added during the implementation stage (both for implementation and information); and
costs are less for CTC during the application stage (including the issuing and verification of a Certificate of Origin).