Rules of Origin, Trade, and Customs

Author:Paul Brenton and Hiroshi Imagawa

    This chapter has benefited from the comments and suggestions of Antoni Estevadeordal, Moshe Hirsch, Holm Kappler, Kunio Mikuriya, Mark Pearson, and Kati Suominen, to whom the authors are most grateful. This paper reflects the views of the authors and should not in any way be attributed to the organizations with which they are or have been affiliated.

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Determining the country of origin or "nationality" of imported products is a requirement for applying basic trade policy measures such as tariffs, quantitative restrictions, antidumping and countervailing duties, and safeguard measures as well as for Page 184 requirements relating to origin marking, public procurement, and for statistical purposes. Such objectives are met through the application of basic or nonpreferential rules of origin. Countries that offer zero or reduced duty access to imports from certain trade partners will apply another and often different set of preferential rules of origin to determine the eligibility of products to receive preferential access. The justification for preferential rules of origin is to prevent trade deflection, or simple transshipment, whereby products from nonpreferred countries are redirected through a free trade partner to avoid the payment of customs duties. Hence the role of preferential rules of origin is to ensure that only goods originating in participating countries enjoy preferences. Therefore, preferential rules of origin are integral parts of preferential trade agreements such as bilateral and regional free trade agreements and the nonreciprocal preferences that industrial countries offer to developing countries.

The nature of rules of origin and their application can have profound implications for trade flows and for the work of customs. Rules of origin can be designed in such a way as to restrict trade and therefore can and have been used as trade policy instruments. The proliferation of free trade agreements with accompanying preferential rules of origin is increasing the burdens on customs in many countries with consequent implications for trade facilitation. Perhaps surprisingly, given their potential to influence trade flows, rules of origin is one area of trade policy that has been subject to very little discipline during the almost 50 years of the multilateral rules-based system governed by the General Agreement on Tariffs and Trade (GATT) and more recently the World Trade Organization (WTO). It is also worth noting that during this period the determination of the country of origin of products has become more difficult as technological change, declining transport costs, and the process of globalization have led to the splitting up of production chains and the distribution of different elements in the production of a good to different locations. The issue becomes which one or more of these stages of production define the country of origin of the good.

This chapter seeks to summarize the key issues relating to both preferential and nonpreferential rules of origin and to highlight the economic impact that rules of origin can have. It concentrates on the implications of rules of origin for customs, drawing on a recent survey of customs administrations throughout the world. The main conclusion is that the specification and implementation of rules of origin can have significant effects both on traders and on the work of customs. Complex rules of origin that differ across countries and agreements can be a significant constraint on trade and a substantial burden on customs and on the improvement of trade facilitation. The nature of the rules of origin can act to undermine the stated intentions of preferential trade agreements.

The first section of this chapter explains what is meant by origin. The second section examines methods for determining substantial transformation. The third section discusses the current situation with regard to nonpreferential rules of origin, where a concerted attempt (yet to bear fruit) has been made to harmonize the rules regarding wholly obtained products and substantial transformation. The fourth section elaborates on the definition of preferential rules of origin for which, to date, there has been no attempt to achieve harmonization and for which there are no real and effective multilateral disciplines. The fifth section looks at the rules of origin in existing free trade and preferential trade agreements. The sixth section reviews the economic implications of rules of origin. The seventh section discusses the links between the rules of origin and the use of trade preferences. The eighth section analyzes the use of the rules of origin as a tool of economic development. The ninth section deals with the costs of administering preferential rules of origin by customs. The tenth section looks at the Doha Round and the rules of origin. The final section provides some operational conclusions.

Defining Origin

When a product is produced in a single stage or is wholly obtained in one country the origin of the product is relatively easy to establish. This applies mainly to natural products and goods made entirely from them and hence products that do not contain imported parts or materials. Proof that the product was produced or obtained in the preferential trade partner is normally sufficient. For all other cases in which two or more countries have taken part in the production of the good, the rules Page 185 of origin define the methods by which it can be determined in which country the particular product has undergone sufficient working or processing or has been subject to a substantial transformation (in general these terms can be used interchangeably). A substantial transformation is one that conveys to the product its essential character.

Methods for Determining Substantial Transformation

Unfortunately, there is no simple and standard rule of origin that can be identified as determining the nationality of a product. The International Convention on the Simplification and Harmonization of Customs Procedures (the Revised Kyoto Convention) defines (in Annex D1 to the convention) the three main techniques for the determination of origin: change of tariff classification, value-added, and specific manufacturing process.

Change of Tariff Classification

Origin is granted if the exported product falls into a different part of the tariff classification to any imported inputs that are used in its production. This tariff-shift method forms the basis of the efforts by the World Customs Organization (WCO) to harmonize nonpreferential rules of origin. Application of this approach has been enabled by the widespread adoption of the Harmonized System (HS) whereby the majority of countries throughout the world (more than 190) are now classifying goods according to the same harmonized categories. There is, however, the issue of the level of the classification at which change is required. Typically it is specified that the change should take place at the heading level (that is, at the four-digit level of the HS).1 The following are examples of simple HS headings:

* beer made from malt (HS 2203)

* umbrellas and sun umbrellas (HS 6601).

The following is an example of a more sophisticated heading:

Machinery, plant or laboratory equipment, whether or not electrically heated (excluding furnaces, ovens and other equipment of heading 8514), for the treatment of materials by a process involving a change of temperature such as heating, cooking, roasting, distilling, rectifying, sterilizing, pasteurizing, steaming, drying, evaporating, vaporizing, condensing or cooling, other than machinery or plant of a kind used for domestic purposes; instantaneous or storage water heaters, non-electric (HS 8419).

However, the HS was not designed specifically as a vehicle for conferring country of origin; its purpose is to provide a unified commodity classification for defining tariff schedules and for the collection of statistics. Thus, in particular cases it can be argued that change of tariff heading will not identify substantial transformation, while in other cases substantial transformation can occur without change of tariff heading. As a result, schemes using the change of tariff heading criterion usually provide for a wide range of exceptions so that other criteria must be satisfied to confer origin.

The change of tariff classification can provide both a positive test of origin, by stating the tariff classification of imported inputs that can be used in the production of the exported good (for example, those in a different heading), and a negative test by stating cases where change...

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