Last month, Italy’s minister of agriculture made headlines when he claimed that Italy’s government did not intend to ratify the Comprehensive Economic and Trade Agreement (CETA) concluded between Canada and the European Union (see Italy’s Decision on CETA Ratification – What Does It Really Mean?). Leaving aside the discussion of whether or to what extent such a decision would actually affect the provisions of the CETA that are exclusively within EU competence and have been in force since September last year, it is interesting to note that Italy is Europe’s third-largest exporter to Canada, after Germany and the United Kingdom. In 2017, goods imported into Canada from Italy totalled approximately CA $8.15 billion. These goods included motor vehicles ($446.8 million), wine ($441 million), clothing and apparel products ($321.7 million), medicaments in measured doses or retail packages ($263.9 million), leather handbags ($116.8 million), olive oil ($108.7 million), and a range of other products. In comparison, Canada exported about $2.29 billion in goods to Italy during the same year.
Since entering into force, the CETA has provided EU exporters — including producers of agricultural and manufactured goods in Italy — with competitive advantages and new market access opportunities in Canada. For Italian (and other EU) producers of apparel products, for example, the CETA’s liberal rules of origin and “origin quotas” greatly enhance market access and provide a significant advantage over competitors from other countries, including those based in Canada’s other trading partners.
The CETA Advantages for EU Apparel Products
EU apparel products, particularly from Italy, have long been an important part of the Canadian market. Despite high customs tariffs of 17 to 18 percent, the value of EU apparel products imported into Canada was significant before the CETA entered into force. In 2016, for example, EU imports totalled $592 million, of which imports from Italy accounted for $295 million (almost 50 percent). In that year, the total Canadian market for imported apparel products was $11.6 billion, and EU market share was about 5.1 percent.
The high customs tariffs that had historically limited the competitiveness and, thus, the market share of EU apparel products were eliminated when the CETA entered into force. Thus, products previously subject to customs duties at rates of 17 to 18 percent may now be imported on a duty-free basis, provided that the applicable “rules of origin” set forth in the CETA’s Origin Protocol are satisfied. This preferential tariff treatment equates to a new competitive advantage of 17 to 18 percent in the Canadian market, allowing EU producers and exporters to compete at lower landed costs and/or greater profit margins.
Considering the total value of the Canadian market for imported apparel products, one would expect this change in the competitive landscape to open up market access opportunities, allowing EU exporters to capture greater shares in the Canadian market. Although it is too early to draw any conclusions, there are indications that this may already be happening. A year-to-date comparison of the trade statistics for the first five months in 2018 (under the full force of the CETA) and for the same period in 2017 (prior to the CETA) indicates that imports of EU apparel products into Canada have increased an average of 20.6 percent, while imports from other countries have generally decreased, shrinking by 0.9 percent overall (see Industry Canada, “Trade Data Online”, available at http://www.ic.gc.ca/eic/site/tdo-dcd.nsf/eng/Home).
Liberal Rules of Origin = Competitive Advantages
In assessing how the CETA has changed the competitive landscape in Canada for imported apparel products, an important consideration is that the CETA rules of origin are generally more liberal than the rules of origin under Canada’s other regional trade agreements. A rule of origin is said to be more liberal when it allows producers to use a higher proportion of “non-originating” materials (i.e., materials sourced from third countries outside the region covered by the agreement) in the production of “originating” goods eligible for preferential tariff treatment. Liberal rules of origin provide greater flexibility to producers, allowing them to take advantage of efficient international supply chains, which helps to lower their costs of production and increase their competitiveness.
A brief comparison of the product-specific rules of origin applicable to men’s suits (tariff heading 62.03) under the CETA and the North American Free Trade Agreement (NAFTA) provides a practical example. The rate of customs duty that ordinarily applies to these goods is 18 percent for suits of wool and 17 percent for suits of cotton and other fibres. Under both the CETA and the NAFTA, these goods may be imported into Canada on a duty-free basis, provided that the applicable rules of origin are satisfied.
The NAFTA rules of origin are relatively strict, generally requiring suits under tariff heading 62.03 to be made using fabric woven from yarn produced in one of the NAFTA countries. In comparison, the CETA rules of origin allow non-originating yarn from a third country to be used in weaving the fabric that is used to make up the garments.
Further, where a suit is made from printed fabric, the CETA rules of origin allow manufacturers to use unprinted, non-originating fabric woven in a third country, provided that (i) the printing operations, together with at least two preparatory or finishing operations (e.g., bleaching, heat setting, raising, calendering, shrink resistance processing, impregnating, mending, etc.), are done on the fabric in a CETA country, and (ii) the value of the unprinted, non-originating fabric does not exceed 47.5 percent of the transaction value or ex-works price of the finished suit.
Under the CETA, therefore, manufacturers of suits have broader access to the basic production materials, i.e., yarns and/or unprinted fabrics of wool, cotton, or other fibres. This allows them to leverage the most efficient sources of supply available in international markets. In principle, this may provide EU producers with a competitive advantage over their U.S. competitors in the Canadian market.
The CETA Origin Quotas for Apparel Products
The CETA origin quotas are innovative provisions that allow limited quantities of certain kinds of 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 product-specific rules of origin that otherwise apply. The origin quotas are set forth in Annex 5-A of the CETA Origin Protocol, and are administered in Canada by the Trade Controls Bureau of Global Affairs Canada.
The CETA provides origin quotas covering a broad range of apparel products exported from the European Union to Canada. Returning to our example of men’s suits, the origin quotas permit EU manufacturers to use 100 percent non-originating fabric woven in a third country to produce the following “originating” goods for export to Canada on a duty-free basis: up to 39,000 wool suits under tariff subheading 6203.11; and up to 281,000 suits, ensembles, jackets, blazers, trousers, or similar articles made from cotton or other textiles under tariff subheadings 6203.12-49 (see Table C.4 of Annex 5-A of the Origin Protocol). The “sufficient production” required to transform the non-originating fabric into an “originating” good involves only the “cutting of fabric and making up” of the garment. Although these quotas cover a limited quantity of goods each year, the highly liberal rule of origin provides tremendous flexibility to EU producers, allowing them the freedom to optimize their costs of production through international supply chain efficiencies, while enjoying the benefits of preferential tariff treatment and enhanced market access under the CETA.
It is worth noting that the same highly liberal rule of origin applies to the CETA origin quotas for other EU apparel products exported to Canada, including e.g., women’s suits and business attire, shirts, track suits, sports wear and swimwear, and coats, etc.
Enterprises that wish to take advantage of these origin quotas for EU apparel products will need to apply to the Trade Controls Bureau for shipment-specific import permits. These permits are issued on a “first-come, first-served” basis. Once the origin quota for a category of EU apparel products has been full utilized, no further import permits will be issued under that quota until 1st January of the following year. For more information, see Trade Controls Bureau (Global Affairs Canada), Notice to Importers (Serial No. 899), “Textiles and Apparel for Import to Canada from the European Union and its Member States (Items 86.98 and 86.99 on Canada’s Import Control List)” (September 1, 2017), available online at http://www.international.gc.ca/controls-controles/textiles/notices_imp_avis/899.aspx?lang=eng.
Through preferential tariff treatment accorded under the liberal rules of origin and the innovative, highly liberal “origin quotas”, the CETA provides unprecedented market access opportunities in Canada for producers, exporters, and importers of EU apparel products. While the elimination of customs duties equates to a 17-18 percent competitive advantage in the Canadian market, this is only the starting point for the analysis. The CETA’s rules of origin may provide EU stakeholders with an edge over international competitors from Canada’s other trading partners to the extent that they permit EU goods to satisfy the requirements for preferential treatment at lower costs of production.
The foregoing is just an example of how the CETA is creating new trade opportunities for businesses in the European Union and Canada. 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 strategically planning your production processes.
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.