Determining the proper country of origin for imported merchandise is a significant and growing challenge in international trade. Consider the case of an importer that wishes to bring garments into the United States in conjunction with a government contract. The fabric is made in South Korea; the garments are sewn together in Mexico. What is the country of origin for the resulting import? Is it South Korea? Mexico? Do the goods qualify for duty-free status under the North American Free Trade Agreement (NAFTA)? May goods of either country be supplied pursuant to a government contract?
Knowing a product’s country of origin is important for determining import duties, product labeling requirements, and even whether the merchandise can be sold to certain customers. This article presents a few of the more common tests for determining country of origin, and the conditions under which they apply.
Substantial Transformation: The Standard Rule
The country of origin of imported merchandise is normally determined by reference to the last country in which the imported merchandise was “substantially transformed”—that is, subjected to a process that gives it a new name, use or essential character. For example, steel wire is substantially transformed when it is woven into chain-link fencing. However, galvanizing the fencing does not substantially transform it—it remains essentially the same product. Similarly, making orange juice from oranges substantially transforms the orange; however, merely reconstituting orange juice concentrate through the addition of water does not lead to a substantial transformation.
The substantial transformation test is inherently subjective; there may be room for disagreement as to whether a particular operation substantially transforms a product or not. Importers can obtain guidance by reference to the customs ruling letters available here, or by requesting a binding ruling from U.S. Customs and Border Protection (CBP) as to the country of origin of any specific product.
Free Trade Agreements: Tariff Shifts and Regional Value Content
In order for imported merchandise to qualify for duty-free status under free trade agreements (FTAs) such as NAFTA, the merchandise must meet the origin rules specific to that agreement. FTA origin rules generally involve a system of “tariff-shifts,” which may be combined with “regional value content” requirements. These rules cover merchandise that was not wholly produced or manufactured in an FTA-origin country—meaning that the merchandise includes raw materials or parts from a country not subject to the FTA in question.
Tariff shift rules require merchandise to undergo a prescribed change in tariff classification while in an FTA country in order to qualify as FTA-origin merchandise. Value content rules specify the percentage of the product’s value that must be attributable to processing or manufacture in a FTA country in order for the product to qualify as an FTA-origin good. The tariff shift and regional content rules applicable to each FTA to which the United States is a party are laid out in the General Notes to the Harmonized Tariff Schedule of the United States (HTSUS).
Tariff shift rules are fairly easy to apply. For example, suppose you are importing Australian snowboards into the United States. Snowboards are classifiable under Chapter 95 of the HTSUS. A review of the US-Australia FTA tariff shift rule reveals that snowboards imported into the U.S. from Australia, but not wholly produced in Australia, will be given duty-free status only if the non-Australian inputs were not themselves classifiable under Chapter 95 when first brought to Australia.
Determining whether imported merchandise meets regional value content requirements can be more complicated, due to the level of accounting specificity involved. Most of the FTAs that involve regional value content involve a comparison between the price actually paid for the good or materials at the time they were first imported into FTA territory, and the price paid or payable for the good upon its export to another FTA country. However, where related parties are involved in the transactions, FTA rules often require that the net cost of the various items involved be calculated. In any case, in order to establish the requisite regional value content, the importer must know the value of the non-originating materials.
Note that a product that does not meet FTA origin rules may still qualify as a good of an FTA country under the substantial transformation analysis; however, all applicable tariffs must be paid.
Country of Origin for Labeling Purposes: Imports and the “Made in the USA” Rule
Under Customs’ regulations, all imported merchandise must be clearly and legibly marked with its country of origin, as determined under either the substantial transformation or FTA-specific rules. An exemption to marking may apply whenever merchandise is either incapable of being marked (for example, small beads, feathers, etc), or where the purchaser of the merchandise intends to substantially transform it so that gains a new name, use or essential character.
Circumstances may arise in which an importer or purchaser of imported merchandise wishes to label imported merchandise or goods produced from imported merchandise as products of the USA. For example, a manufacturer may source materials or products in the United States, and send them abroad for packaging or minor finishing operations. In other cases, a manufacturer may assemble or otherwise manufacture items in the United States from foreign materials.
U.S. Federal Trade Commission (FTC) regulations prohibit any product from being labeled as a product of the United States unless all or substantially all of the component materials are of U.S. origin. Accordingly, a gas grill that contains only imported knobs, but which is otherwise composed of all U.S. materials, may be labeled as a product of the USA. However, a hammer with an imported head and a U.S. handle may not.
The emphasis of the FTC’s regulations is on giving consumers complete and clear information on the origin of merchandise. Accordingly, “Assembled in the USA from imported materials” might be acceptable for the hammer described above. The FTC also permits truthful claims of limited U.S. content, such as “Made from 60% U.S. materials.”
Country of Origin for Government Contracts Purposes
U.S. government contracts law permits the purchase and supply of non-U.S. merchandise only on a limited basis. The statutes that most commonly apply in determining whether imported goods qualify for government contracts are the Trade Agreements Act (TAA) and Buy America Act (BAA). Each of these laws approaches the question of country of origin differently.
For government contracts subject to the TAA, goods may be supplied not only from the United States, but from a limited number of “designated countries,” consisting of members of the World Treaty Organization’s (WTO’s) Government Procurement Agreement, free trade agreement partners and certain countries whose economies the United States wishes to stimulate. The TAA uses the standard substantial transformation rule to determine the country of origin of merchandise supplied to the government. For example, goods produced in the United States from imported components will be considered U.S. merchandise so long as the imported components are substantially transformed through further manufacturing in the United States. Similarly, goods that undergo a final substantial transformed in a designated country are also permissible.
Unlike contracts under the TAA, those that operate under the BAA permit only U.S.-origin merchandise to be supplied. The BAA does not use the substantial transformation test to determine origin. Rather, it requires that the product be an unmanufactured good wholly produced or mined within the United States or, if the good is manufactured, that at least fifty percent of its value be attributable to U.S. processing/production.
In addition, the American Recovery and Reinvestment Act (ARRA) permits—absent certain exemptions—only U.S.-origin iron, steel and manufactured goods to be supplied for construction projects funded by the Act. The ARRA does not specify the country of origin test to be used in determining whether merchandise is of U.S. origin. However, interim regulations dealing with iron and steel indicate that “all manufacturing processes must take place in the United States,” except those dealing with refining steel additives. With respect to non-iron/steel manufactured goods, at least one Federal agency—the Environmental Protection Agency—has applied the substantial transformation test to determine whether such goods qualify as U.S. merchandise.
By being aware of country of origin rules, importers can ensure that their goods enter at the lowest possible cost, comply with labeling rules and regulations, and can better target goods to the right customers.