Bernardine Adkins Sean Giles March 12 2021 Back to basics: free trade agreements Gowling WLG | International Trade - International Bernardine Adkins, Sean Giles International Trade IntroductionWTOWhat is an FTA?Interaction between FTAs and WTO rulesHow can businesses benefit from preferential tariff treatment under FTAs?Tariff classificationImportance of rules of originProving compliance with applicable rules of origin under FTAsAvoiding pitfallsIntroductionAs the United Kingdom and the European Union give effect to their new bilateral trading arrangement, the EU-UK Trade and Cooperation Agreement (TCA), this article considers:where free trade agreements (FTAs) such as the TCA sit in the context of the World Trade Organisation (WTO) rules;the nature of FTAs and their purpose in the context of international trade; andthe key elements for businesses to consider in the context of seeking to benefit from FTAs, including:preferential rules of origin;tariff classification; anddirect transport.WTOThe WTO is a multinational organisation comprising 164 members. The WTO fulfils a number of roles, including serving as a forum for the liberalisation of international trade (eg, by reducing tariffs and removing non-tariff barriers) and settling international trade disputes (for further details please see "World Trade Organisation: an introduction").International trade is governed by a number of treaties (eg, the General Agreement on Tariffs and Trade (GATT) and the General Agreement on Trade in Services), the implementation of which is overseen by the WTO under the WTO Agreement.The WTO Agreement permits its members to conclude bilateral and multilateral FTAs and offer preferential tariff access on a unilateral basis to developing nations. These trading arrangements exist alongside the commitments of WTO members under the abovementioned international treaties.These arrangements can take a number of forms, including:FTAs between two or more customs territories, which may be individual countries or customs unions of several countries (eg, the European Union);unilateral preferential trading arrangements (PTAs), whereby a country unilaterally grants tariff-free or reduced tariff access to a developing country; andmultilateral regional trade agreements (RTAs), under which a number of countries form a broad economic alignment and seek to reduce international trade barriers between them.What is an FTA?An FTA is an international treaty between two or more customs territories that seeks to reduce or eliminate barriers to trade and encourage a strong economic relationship between the signatories.The scope of an FTA depends on the preferences of the signatories (and their respective negotiating power).FTAs do not remove all controls on imports and exports. Rather, they seek to encourage and foster trade relations between signatories by, for example:implementing trade facilitation measures to reduce customs formalities (eg, documentation required to import goods);reducing or removing import tariffs; andremoving regulatory restrictions on the goods and services traded between the signatories.FTAs also include rules on how businesses can enjoy preferential market access under the FTA, such as the applicable rules of origin (see below).Comprehensive FTAs also include provisions to liberalise trade in services, such as:the mutual recognition of professional qualifications; andgreater access to public procurement opportunities for businesses located in the countries of the signatories.Interaction between FTAs and WTO rulesThe WTO agreements contain a general most-favoured-nation (MFN) principle. First concluded at a multilateral level under the GATT 1947, the MFN principle provides that members must not discriminate between WTO trading partners. This means that WTO members must accord one another equal tariff treatment in the context of their markets (ie, if a WTO member grants a lower tariff rate to one WTO member, it must grant this lower tariff rate to all WTO members). This principle also extends to rules and formalities applicable to imports and internal taxes and regulatory measures.By way of an exception, FTAs (and PTAs and RTAs) allow WTO members to depart from the MFN principle. Under an FTA, WTO members may grant each other preferential tariff treatment, while applying the MFN principle when trading with those WTO members that are not party to the relevant FTA. To qualify for this exception, the FTA must eliminate tariffs and other restrictive regulations in relation to "substantially all the trade" between the states in questionHow can businesses benefit from preferential tariff treatment under FTAs?Each FTA contains specific rules with which businesses must comply in order to benefit from the preferential tariff rates agreed by the signatories. Annex II of the WTO Agreement on Rules of Origin sets out a common framework with which WTO members must comply when formulating preferential rules of origin (including that these rules should be notified to the WTO).Typically, these rules require (among other things):compliance with so-called 'product-specific rules of origin' (explored in more detail below);that goods are shipped directly from one party's territory to another (the Transport Rule); and/orwhere goods are transhipped via a third country, that the goods are not manipulated in the country of transit – that is, only basic operations (eg, unpacking and repacking) are carried out and the goods remain under the customs supervision in the country of transit (ie, they are not customs cleared or offered for sale in the transit country).Importers typically have to provide evidence of compliance with these requirements in the form of a certificate of origin and transport documents confirming the transit route of the imported goods.Tariff classification To understand which tariff rate applies to an importer's goods, it is first necessary to determine the goods' tariff classification.Product-specific rules of origin under FTAs depend on the tariff classification of the relevant product.Businesses seeking to rely on FTAs should first ensure that they understand the tariff classification of their products.Products are classified by reference to the Harmonised System (HS). The HS is an internationally standardised tariff nomenclature, whereby products are ascribed a numeric code (known as an 'HS code' or 'tariff code') corresponding to the type of product.The HS is organised hierarchically, with 21 sections that are further subdivided into chapters, headings and subheadings. The nomenclature gets more specific with each subdivision (ie, sections are most broad and subheadings are most specific).For example, the HS code for chocolate is 18.06.11, which can be worked out as follows.In this example:'18' designates the chapter classification;'06' designates the heading; and'11' designates the subheading.HS codes are harmonised internationally to six-digit level, but most countries further subclassify goods to an eight or 10-digit level.Product-specific rules of origin under FTAs are generally agreed at chapter or heading level.Importance of rules of originIn order to benefit from an FTA and ensure that the lower or zero tariff rates apply to an importer's goods, businesses must demonstrate that their goods either originate from, or are manufactured in, a territory to which the relevant FTA applies.There are generally four ways in which this can be demonstrated and each type of good will have its own product-specific rule – namely:wholly obtained – this typically applies to agricultural products and natural resources (eg, as potatoes are dug out of the ground, they are clearly wholly obtained in the country in which they were originally planted);regional value content – typically, this is a requirement that a specific percentage of the value contributed to the product was so contributed in the territory of a signatory party. The threshold will vary depending on the type of good and the rules under the relevant FTA;(1)tariff shift – this applies to manufactured goods and requires that sufficient manufacturing takes place within the territory of a signatory party so as to change the tariff classification (ie, the HS code) of a product. Tariff shift rules may take different forms (eg, a change of subheading, a change of chapter heading or a change in chapter). For example, a wooden chair (classified under HS Code 94.01.40) may begin life as oak wood (HS Code 44.03.91). Manufacturing the wood into a chair therefore results in a change in chapter heading (ie, from 44 to 94); andspecific processing – this is common for apparel and requires that a specific type of processing takes place in the territory of a signatory party.(2)Proving compliance with applicable rules of origin under FTAsCustoms authorities will require evidence from an importer that the goods which it is importing have satisfied the applicable rules of origin and the Transport Rule under the relevant FTA.The type of evidence required depends on the country of import and the relevant FTA. Generally, the evidence takes the form of a certificate of origin (the requirements for which are set out within the relevant FTA).(3)Avoiding pitfallsCommon errors that arise when utilising FTAs include:incorrect or missing proofs of origin;incorrect classification of goods and misapplication of rules of origin; andnon-compliance with the Transport Rule.This can lead to businesses incorrectly paying customs duties that they may not have needed to incur. In other circumstances, importers may find that they have been incorrectly paying less duty (eg, because a customs agent has been incorrectly claiming preferential tariff access) and face potential enforcement action from a customs authority (eg, a demand for payment of underpaid import duties).Agents acting on behalf of importers (eg, customs brokers) have no legal responsibility in relation to ensuring compliance with FTAs. Businesses should ensure that they give proper instructions to their agents so as to avoid potential compliance risks. Businesses should also seek legal advice on how to maximise the potential benefits of FTAs and minimise potential compliance risks.For further information on this topic please contact Bernardine Adkins or Sean Giles at Gowling WLG by telephone (+44 207 379 0000) or email ([email protected] or [email protected]). The Gowling WLG website can be accessed at www.gowlingwlg.com.Endnotes(1) A common rule of origin under EU and UK FTAs for vehicles is a limit on the maximum amount of non-originating material present in a finished vehicle (that is, material of an origin other than that of the signatories' territories). For example, under the EU-UK TCA, a vehicle may benefit from preferential tariff treatment only if it has a maximum non-originating value of 45% (ie, 55% of the value content must be generated in the signatories' territories).(2) For example, a shirt may satisfy the product-specific rule of origin under the UK-EU FTA if the following processing takes place "knitting or crocheting combined with making-up including cutting of fabric" (see Annex Orig-2 of the TCA).(3) EU and UK FTAs also provide for the possibility of proof via a statement of origin on an invoice for certain importers. The UK-EU TCA also allows proof of origin in the form of 'importer's knowledge'. This means that importers may claim preferential tariff treatment under the TCA based on the "knowledge that a product is originating [ie, satisfies the rules of origin under the TCA] in the exporting party [ie, the European Union or the United Kingdom]" (see Article Orig.21 of the TCA). Reliance on an importer's knowledge does not require the submission of a certificate of origin to either the United Kingdom or the European Union's customs authorities (or the making out of an invoice declaration). However, there is a requirement that importers maintain (for a minimum of two years) sufficient records to be able to demonstrate that the product satisfies the applicable product-specific rules of origin. This could include a statement of origin by the exporter.