Written by John Weekes, Lori Sterling and Jessica Horwitz
This is the first in a three-part series on new challenges for businesses presented by the USMCA from Canadian and Mexican perspectives. Part two will look at labour and part three at anti-corruption.
On July 1, 2020, the successor free trade agreement to NAFTA entered into force in Canada, Mexico and the United States. The agreement is commonly referred to internationally as the USMCA; in Canada, we call it CUSMA and in Mexico it is called T-MEC. The agreement presents new challenges for businesses, especially in trade & customs, labour and anti-corruption standards.
These three areas were a particular focus for discussion at a webinar roundtable hosted recently by Bennett Jones and the Mexican law firm, Chevez Ruiz Zamarripa, where experienced practitioners shared their perspectives.
Here is a look at new or heightened risks in trade and customs that Canadian companies face under USMCA and suggest some practical mitigation tactics.
Trade and Customs
Although the USMCA maintains the duty-free market access for most goods enjoyed under the NAFTA, the USMCA does little to mitigate the risk of extraordinary tariffs owing to the broader scope of the national security exemption available to governments.1 Canadians have already witnessed this risk, which manifested over the summer in the form of the resumption of a 10-percent U.S. tariff on Canadian aluminum that had previously been in place from June 1, 2018, to May 17, 2019. The tariffs were withdrawn on September 15, 2020, in the face of threatened Canadian retaliation, but with a warning that the U.S. will continue to monitor trade with reference to unilaterally set monthly target volumes.
To mitigate risk, businesses can adopt the following measures.
- Review Contract Terms
- Understand how risk is borne between the parties and who ultimately pays the increased costs arising from the tariffs.
- Consider termination and/or renegotiation rights and their impact on tariff risk sharing between parties.
- Have discussions with customers and suppliers if risk is not appropriately allocated. Consider options for the parties to share risk.
- Diversify Supply Chains
- Diversify sources of supply to be less dependent on counterparties who are in a position to pass along tariffs through contract pricing and/or where supply may be constrained by quotas.
- It is equally important for exporters to diversify their customer base.
- Monitor Trade Levels
- Monitoring trade levels of products important to an enterprise's supply chain can be an early warning indicator of potential action by governments. This is especially true where the products are in politically sensitive sectors or where suppliers are concentrated by electoral jurisdiction(s) and therefore are politically influential. Trade data is available from public sources such as:
Renewed scrutiny and enforcement of rules of origin pose a material risk for businesses. Rules of origin are the criteria under which a product qualifies for preferential treatment under the USMCA. The rules of origin have changed for many products under the USMCA, with some rules becoming more restrictive while others are simplified. Changes to rules of origin can have the indirect effect of increasing duty rates on products that do not qualify under narrower rules.
Although there are changes to rules of origin throughout the tariff schedule, at the roundtable, panelists identified automotive, textiles, electronics, chemicals and plastics as sectors in which rules of origin have notably changed. Enterprises should also be aware that there is no transition period from NAFTA rules so the USMCA rules of origin already apply. To mitigate risk, panelists recommended the following measures.
- Review tariff classification
- Identifying the correct rule of origin is contingent on accurate tariff classification of an item, which itself can be a challenging exercise that is not necessarily intuitive.
- Consider consulting outside experts if there are any doubts about how your products should be classified.
- Review the new USMCA product specific rules of origin
- Identify whether there have been any changes to the rules applicable to your products, and if there have, prepare an updated origin analysis to determine if the goods continue to qualify.
- If goods no longer qualify, consider whether any adjustments can be made to materials sourcing to bring the goods into qualification scope.
- Check the MFN rates of duty, discuss with customers, and perform a cost/benefit analysis
- Claiming preferential treatment under free trade agreements is not mandatory; remember that many products are subject to normal duty rates (most favoured nation or MFN) that are already low or zero.
- Paying the regular tariff rate may in some cases be less costly than the exercise of complying with origin requirements.
- Another factor is that customers may require their inputs to originate in order to meet qualification targets for their own manufactured goods.
- Consider the CPTPP
- Mexico and Canada are both parties to the Comprehensive & Progressive Agreement for Trans-Pacific Partnership (CPTPP). Consider using this agreement if the applicable product-specific rules of origin are more advantageous than under the USMCA.
- Be aware that there is no "cross-cumulation" of origin between the CPTPP and the USMCA, so if an item enters Canada or Mexico with CPTPP qualification, that item would need to be re-qualified under the USMCA before it can be counted toward USMCA regional value content requirements. (The same applies for the Canada-Europe Comprehensive Economic and Trade Agreement (CETA).)
- Update Supply Chain Verification & Compliance
- Update compliance procedures, forms, manuals and staff training, audit procedures, documentation (including certifications of origin) and recordkeeping to ensure that the new rules of origin and administrative requirements under the USMCA are being met.
- Rigorous, documented supply chain compliance is essential to avoiding supply disruptions or unexpected financial or legal liabilities.
The unprecedented economic shock brought by the COVID-19 pandemic coupled with increasing geopolitical tensions have increased the likelihood of rigorous enforcement actions by governments (and in the case of labour measures, potentially by competitors) under the USMCA. Contact Bennett Jones' International Trade & Investment and Governmental Affairs & Public Policy groups to better understand and mitigate your enterprise's risks.
- The U.S., Canada and Mexico all have more latitude in applying the national security clause in the USMCA than they did under NAFTA. In recent years, the U.S. has used Section 232 of the U.S. Trade Expansion Act of 1962 to impose tariffs on Canadian and Mexican companies under the justification that U.S. reliance on imports threatens U.S. domestic national security. Canada and Mexico object to the justification of these tariffs on national security grounds. This issue was not resolved in USMCA talks, and in fact the scope of the national security exemption was diluted by the removal of an itemized list of acceptable national security-based exemptions under the NAFTA (Article 2102), leaving only a vague and undefined reference to "essential security interests" in the USMCA (Article 32.2). The U.S. provided side letters that agreed to give Canada and Mexico a 60-day notice before imposing future national security tariffs. Canada also secured an exemption from the use of Section 232 in the auto sector up to a certain number of vehicles a year. The U.S. has other extraordinary tariff mechanisms as well, such as tariffs under s.301 of the U.S. Trade Act of 1974 and s.337 and the U.S. Tariff Act of 1930 to combat intellectual property violations. Although no such tariffs have been imposed against Canada recently, Canada was placed on the U.S. section 301 "watch list" in 2019.