Since entering into provisional application on 21st September 2017, the Comprehensive Economic and Trade Agreement (CETA) has been creating new opportunities for trade in goods and services for business stakeholders in Canada and the European Union. With respect to trade in goods, the CETA creates new competitive opportunities and supply chain prospects through (i) the progressive elimination of customs duties, (ii) the introduction of highly liberal “origin quotas” for certain product categories, and (iii) “tariff rate quotas” (TRQs) that provide increased access to otherwise restricted market sectors (i.e., cheese in Canada; beef, pork, and other products in the European Union).
It is well known that the CETA eliminates most of the customs duties that previously applied to cross-border trade in Canadian and EU goods. The Government of Canada, for example, explains that while “only 25 percent of EU tariff lines on Canadian goods were duty-free” before the CETA entered into provisional application, “98 percent of EU tariff lines are now duty-free for Canadian goods” (Global Affairs Canada, “CETA: A progressive trade agreement for a strong middle class”, http://www.international.gc.ca/gac-amc/campaign-campagne/ceta-aecg/index.aspx?lang=eng).
What must not be overlooked, however, are the conditions and requirements that businesses must satisfy in order to leverage the benefits of this preferential tariff treatment. Products traded between Canada and the European Union are not automatically eligible for duty-free market access merely because they are classified under tariff items for which the customs duties were reduced to zero under the CETA. Rather, such goods must qualify as “originating” in Canada or the European Union in accordance with the applicable “rules of origin”. These rules are specified in the CETA Protocol on Rules of Origin and Origin Procedures, and they have been implemented into Canadian customs law under the CETA Rules of Origin Regulations and the CETA Tariff Preference Regulations under the Customs Tariff.
Very generally summarized, the rules provide that a product is “originating” if (i) it is “wholly obtained” in Canada or the European Union, (ii) it is produced exclusively from materials that are “wholly obtained”, or (iii) it has undergone “sufficient production” in Canada or the European Union.
These terms warrant some explanation.
Originating Products that are “Wholly Obtained” or Made from “Wholly Obtained” Materials
Generally, a product or material is “wholly obtained” in Canada if it is harvested, extracted, or recovered entirely within Canada. Simple examples include wheat that is grown and harvested on Canadian farms and potash that is extracted from Canadian mines. Special rules apply to goods harvested from the sea or the seabed. For instance, seafood harvested on the high seas by a fishing vessel that is registered and licensed in Canada will qualify as “originating” if certain conditions are satisfied.
In turn, it makes sense that a product manufactured exclusively from “wholly obtained” materials will be considered an “originating” product under the CETA (e.g., a processed food product made in Canada using Canadian agricultural ingredients).
However, an important point here is that such a product does not necessarily need to be produced using 100 percent “wholly obtained” materials. The CETA provides a general tolerance for some “non-originating” materials to be used in the production of “originating” products. Provided that the total value of non-originating materials does not exceed 10 percent of the transaction value or ex-works price of the finished product, the product will generally be considered “originating” and eligible for preferential treatment under the CETA. For Canadian and EU businesses, this tolerance has important implications for optimizing the costs of production and supply chain efficiencies for “originating” products.
Originating Products that have Undergone “Sufficient Production”
An “originating” product may contain a higher proportion of non-originating materials if it has undergone “sufficient production” within Canada or the European Union. The term “sufficient production” refers to processing or manufacturing work that transforms a material or product into something different. This transformation is evidenced through the change — or “shift” — in tariff classification under the Harmonized Commodity Description and Coding System (HS).
For example, if non-originating apples (HS tariff subheading 0808.10) are used to produce apple pies (HS tariff subheading 1905.90), they have undergone production that changes them to not only another heading (08.08 to 19.05), but also to another chapter (8 to 19). What constitutes “sufficient production” for each product is specified in the product-specific rules of origin under Annex 5 of the CETA Origin Protocol. These rules are usually conditioned on regional value content requirements, which impose minimum thresholds for “originating” content and/or maximum thresholds for non-originating content.
The product-specific rule of origin for our apple pie requires that the non-originating ingredients undergo a change to HS heading 19.05 from “any other heading” (e.g., from heading 08.08 for the apples). This rule is conditioned on a number of regional value content thresholds which require, among other things, that the net weight of non-originating flour used in production does not exceed 20 percent of the net weight of the finished product, and the net weight of all non-originating egg and dairy products is no greater than 20 per cent, etc. Notably, there is no limit on the weight of non-originating apples, which are the primary ingredient by weight.
What does this mean in practical terms? Generally, if you were to produce apple pies in Canada for export to the European Union, you could use 100 percent U.S. apples and, provided the finished product satisfies the regional value content requirements for the other ingredients, it would qualify as an “originating” good eligible for duty-free treatment under the CETA.
The apple pie provides a simple illustration; such product-specific rules of origin apply to other manufactured and highly processed products. For producers in Canada and the European Union, understanding these rules means understanding how best to leverage supply-chain options to maximize production cost efficiencies while maintaining eligibility for the preferential tariff treatment that provides a competitive advantage in CETA markets.
Another important rule of origin — with real supply chain implications — is that when a non-originating material undergoes “sufficient production”, and the resulting product is considered to be “originating” under the CETA, no account shall be taken of the non-originating material it contains if it is used in the subsequent production of another product. This rule applies whether or not the material has acquired originating status inside the same factory where the final product is produced. Canadian and EU producers of finished goods that assemble manufactured components or make intermediate inputs for further processing may find this rule helpful for satisfying the regional content value thresholds discussed above.
“Origin Quotas” – Highly Liberal Alternatives to the Product-specific Rules of Origin
Finally, the CETA introduces “origin quotas”, which allow limited quantities of certain products to receive preferential tariff treatment if they satisfy “alternative” rules of origin that are much more liberal and relaxed — and therefore easier to satisfy — than the standard product-specific rules of origin.
The origin quotas are set forth in Annex 5-C of the CETA Origin Protocol, and are administered in Canada by the Trade Controls Bureau of Global Affairs Canada pursuant to the Export and Import Permits Act and its regulations. The origin quotas cover (i) exports from Canada to the European Union of certain processed food products, high-sugar containing products, sugar confectionary and chocolate preparations, fish and seafood products, dog and cat food products, apparel and textile products, and motor vehicles; and (ii) exports from the European Union to Canada of certain apparel and textile products.
To provide an example of how the “alternative” rules operate under the origin quotas, let us return to our apple pie factory. If our apple pies are exported to the European Union under the 35,000 tonne origin quota for “processed foods” (see the Notice to Exporters issued by the Trade Controls Bureau), the applicable rule for “sufficient production” requires only that all of the ingredients undergo a change to HS heading 19.05 from any other heading — there are no regional value content thresholds. This means that the pies could be produced in Canada using 100 percent non-originating ingredients, including apples, flour, sugar, dairy products, eggs, etc. As these materials each undergo a change to HS heading 19.05 from other headings (in other chapters) in the production of apple pie, the alternative rule will be satisfied regardless of how much non-originating content is used. This could have important implications for production cost efficiencies.
To export our apple pies under the origin quota, we would need to apply to the Trade Controls Bureau for shipment-specific export permits, which are issued for processed food products on a “first-come, first-served” basis. Once the annual quota of 35,000 tonnes is fully utilized, no further export permits will be issued until the beginning of the next calendar year.
The origin quotas for certain apparel products, sugar confectionary, chocolate preparations, and dog and cat food products are administered in the same way, through shipment-specific export permits issued on a “first-come, first-served” basis. Export permits for Motor vehicles and high-sugar containing products are issued under application policies administered by the Trade Controls Bureau and require interested Canadian producers and exporters to apply by 1st October of the preceding year. No export permits are required for exports from Canada to the European Union of seafood products and textile products under the origin quotas; the European Union manages these imports on a “first-come, first-served” basis on the EU side.
Analyzing How Your Business Will Benefit under the Preferential CETA Market Access
The foregoing are a few examples of how the CETA is creating new opportunities for businesses in Canada and the European Union. Stakeholders on both sides of the Atlantic are currently exploring how the CETA applies to the specific circumstances of their businesses and supply chains, and how they can leverage its provisions to obtain a competitive edge in Canadian and EU markets. In order to yield the best returns, this analysis must be done on a product-by-product basis.
If you are a producer or exporter of products in either Canada or an EU country, an analysis of how your goods and supply chains align with the CETA rules of origin may open up new short-term and long-term opportunities, in terms of both competitive market access and strategic production planning.
Tereposky & DeRose LLP regularly provides advice on how to apply and leverage the provisions of international trade agreements, including the CETA, the NAFTA, and the forthcoming CPTPP. Should you have any questions regarding potential opportunities under these trade agreements or any other trade related issues, we are at your disposal.