The North American Free Trade Agreement (NAFTA) grants preferential tariff treatment to a variety of goods traded among the United States, Canada and Mexico. Maximum benefits are reserved for those goods that originate in the region.
As defined by NAFTA, originating describes those goods that meet the requirements of Annex 401 of the Agreement. Annex 401, which is now General Note 12 of the Harmonized Tariff Schedule of the U.S., establishes which goods originate under the Agreement and precludes goods from other countries from obtaining those benefits by merely passing through Canada, Mexico or the United States.
In Part 1 in this series of articles on the NAFTA rules of origin, I outlined five different ways in which companies can determine if their goods qualify for NAFTA. This article will take a closer look at Preference Criterion A and B. If your product qualifies for NAFTA using one of these criteria, you would fill in the appropriate letter in column 7 on the NAFTA Certificate of Origin document.
Preference Criterion A
Goods wholly obtained or produced entirely in Canada, Mexico or the United States that contain no foreign material or parts from outside the NAFTA territory qualify under NAFTA as preference criterion A. Examples of this criterion are:
- Silver mined in Mexico extracted in the territory.
- Wheat grown in Canada harvested in the territory.
- Live animals born and raised in Canada, Mexico or the United States.
- Goods obtained from hunting, trapping or fishing in Canada, Mexico or the United States.
A manufactured product would be difficult to qualify under preference criterion A. All parts and raw materials used to manufacture the product would have to be wholly obtained or produced in one of the territories.
Preference Criterion B
Even if they contain non-originating materials, goods may originate in Canada, Mexico or the United States if the materials satisfy the rule of origin specified in General Note 12. The rules of origin are commonly referred to as specific rules of origin and are based on a change in tariff classification, a regional value-content requirement, or both.
General Note 12 gives the applicable rule of origin per the Harmonized Tariff Schedule (HTS) number or grouping of numbers, so you must know the HTS number of your goods to find its specific rule of origin and determine if the rule has been met.
When a rule of origin is based on a change in tariff classification, each of the non-originating materials used in the production of the goods must undergo the applicable change as a result of production occurring entirely in the NAFTA region. This means that the non-originating materials are classified under one tariff provision prior to processing and classified under another upon completion of processing. The specific rule of origin defines exactly what change in tariff classification must occur for the goods to be considered originating.
Frozen pork meat (HTS 02.03) is imported into the United States from Hungary and combined with spices imported from the Caribbean (HTS 09.07-09.10) and cereals grown and produced in the U.S. to make pork sausage (HTS 16.01). The General Note 12 rule of origin for HTS 16.01 states: "A change to heading 16.01 through 16.05 from any other chapter."
Since the imported frozen meat is classified in Chapter 2 and the spices are classified in Chapter 9, these non-originating materials meet the required tariff change. One does not consider whether the cereal meets the applicable tariff change since it was grown and produced in the U.S. Only non-originating materials must undergo the tariff change.
Regional Value Content
Some specific rules of origin require that a good have a minimum regional value content, meaning that a certain percentage of the value of the goods must be from North America. There are two formulas for calculating the regional value content. The exporter or producer may choose between these two formulas: the transaction value method or the net cost method.
Having two methods gives producers more than one way of demonstrating that the rule of origin has been satisfied.
Transaction Value Method
The transaction value method is generally simpler to use. The transaction method calculates the value of the non-originating materials as a percentage of the transaction value of the good. Because the transaction value method permits the producer to count all of its costs and profit as territorial, the required percentage of regional value content under this method is higher than under the net cost method.
The formula for calculating the regional value content using the transaction value method is:
|TV - VNM|
|RVC =||--------------||x 100|
Where RVC is the regional value content, expressed as a percentage; TV is the transaction value of the good adjusted to an FOB basis; and VNM is the value of non-originating material used by the producer in the production of the good.
The regional value content must be a minimum of 60% when the transaction value is used.
Net Cost Method
This method calculates the regional value content as a percentage of the net cost to produce the good. Net cost represents all of the costs incurred by the producer minus expenses for sales promotion (including marketing and after-sales service), royalties, shipping and packing costs and non-allowable interest costs. The percentage content required for the net cost method is lower than the percentage content required under the transaction value method because of the exclusion of certain costs from the net cost calculation.
The formula for calculating the regional value content using the net cost method is:
|NC - VNM|
|RVC =||--------------||x 100|
Where RVC is the regional value content, expressed as a percentage; NC is the net cost of the good; and VNM is the value of non-originating materials used by the producer in the production of the good.
An electric hair curling iron (HTS 8516.32) is made in Mexico from Japanese hair curler parts (HTS 8516.90). Each hair curling iron is sold for US$4.40; the value of the non-originating hair curler parts is US$1.80. The General Note 12 rule of origin for HTS 8516.32 states:
The first of these two rules is not met since there is no heading change, therefore the producer must verify if the curling irons can qualify under the second rule. In the second rule the required subheading change is met (from HTS 8516.90 to 8516.32) so one proceeds to calculate the regional value content. The regional content under the transaction value method is:
|($4.40 - $1.80)|
|----------------------||x 100||= 59.1%|
The hair curler is not considered an originating good under this method, since the required regional value content is 60 percent where the transaction value is used.
Instead, the producer uses the net cost method. The total cost of the hair curler is US$3.90, which includes US$0.25 for shipping and packing costs. There are no costs for royalties, sales promotion or non-allowable interest. The net cost is therefore US$3.65. The regional value content under the net cost method is:
|($3.65 - $1.80)|
|----------------------||x 100||= 50.7%|
The hair curler would be considered originating since the required regional value content is 50 percent when the net cost method is used.
Part 3 of this series will address preference Criterion C and unassembled goods.