U.S. Customs Proposes Broadly Applicable Changes to Rules of Origin for Goods from Canada and Mexico

In general, all articles imported into the United States must be declared with their country of origin. An article’s country of origin is important for a number of purposes, including duty assessment (e.g., whether merchandise is subject to Section 301 duties), origin marking, eligibility for certain government procurement contracts, admissibility determinations, and administering quotas. Collectively, the tests used to determine the country of origin of an article for these purposes, that is, all purposes except trade preference programs (like free trade agreements), are known as non-preferential rules of origin.

CBP applies the “substantial transformation” standard to determine a product’s country of origin for non-preferential purposes. That is, when an article is produced in one country from components or materials sourced from multiple countries, and/or undergoes manufacturing operations in more than one country, its country of origin will be based on where the article was last substantially transformed.

Two different methods exist for determining whether manufacturing operations result in a substantial transformation — the traditional substantial transformation test, and the NAFTA Marking Rules. The traditional substantial transformation test is a subjective, fact-intensive analysis informed by judicial opinions and administrative rulings in which CBP applies judicially developed tests to specific facts on a case-by-case basis. In general, CBP uses the traditional substantial transformation test to determine a product’s origin for non-preferential purposes. While the test is defined as a change in name, character, or use, it is applied by engaging in a fact-specific analysis of a number of factors such as the number, value, and origin of the components; the production location, sophistication, and time; labor cost relative to component values; and the significance of certain significant components to the finished product. Products imported into the United States from Canada or Mexico, however, are also subject to the NAFTA Marking Rules, which are objective, tariff-shift rules that apply only for determining the country of origin of a product for marking purposes.²

As such, nontextile products (as discussed later) imported into the United States from Canada or Mexico are currently subject to two different substantial transformation tests — the subjective traditional transformation test that applies for non-preferential purposes (except marking), and the objective NAFTA Marking Rules that apply only for marking purposes. While the two tests “are intended to produce the same determinations as to origin,” CBP occasionally reaches different conclusions when applying both tests to the same facts.³ For example, in Headquarters Ruling Letter (HQ) H300226 (September 13, 2018), CBP concluded that assembly operations in Mexico to produce an electric motor satisfied the NAFTA Marking Rules but were not sufficient to satisfy the traditional substantial transformation test; therefore, the product had to be marked to indicate that it had a country of origin of Mexico, but the importer had to pay the Section 301 duty applicable to Chinese-origin articles.

Notice of Proposed Rulemaking

The NPRM proposes to apply the NAFTA Marking Rules consistently across all non-preferential origin determinations that CBP makes for merchandise imported from Canada and Mexico. This would eliminate having to apply two different substantial transformation tests when making non-preferential origin determinations for imports from Canada and Mexico, thereby foreclosing the possibility of a product having one origin for marking purposes and a different origin for other non-preferential purposes, such as additional duties and government procurement under the Trade Agreements Act (i.e., situations like in HQ H300226).⁴

CBP provides two main reasons for the proposed rule. First, extending the NAFTA Marking Rules “will provide continuity for the importing community” because they have been in effect since 1994 and importers have “made extensive efforts” in applying these rules. Second, the NAFTA Marking Rules are a “codified, reliable, simplified, and standardized method” for determining the country of origin for customs purposes. By contrast, the subjective nature of the traditional substantial test “has engendered a significant degree of uncertainty both with Customs and in the trade community as regards the effect that a particular type of processing should have on an origin determination”. In short, the proposed rule changes are intended to reduce administrative burdens and inconsistency for non-preferential origin determinations for merchandise imported from Canada or Mexico. CBP has previously adopted the NAFTA Marking Rules as the definition of the substantial transformation test on a broader basis for all non-preference rules of origin for textile products; however, in contrast to the current proposal, it adopted the NAFTA Marking Rules for all textile products, regardless of the country(ies) of production.

The direct effect of the NPRM would be on nontextile products imported into the United States from Canada or Mexico that currently have two different origins (one for marking and one for other non-preferential purposes). If the proposed amendments are adopted, such products will have one country of origin. In that regard, the portions of CBP rulings that apply the traditional substantial transformation test to manufacturing operations in Mexico or Canada (like HQ H300226) will likely be revoked by operation of law (see 19 C.F.R. §177.12(d)(1)(i)). Companies negatively affected by such rulings therefore stand to benefit and should consider filing a comment in support of the NPRM.⁵

Other relevant takeaways from the NPRM include the following:

• The Section 301 duties on Chinese-origin articles have caused many companies to relocate certain manufacturing operations out of China. The traditional substantial transformation test applies when evaluating whether those operations are sufficient to confer non-China origin for purposes of Section 301. The NAFTA Marking Rules, however, are typically easier to satisfy than the traditional substantial transformation test (see, e.g., HQ H300226, where manufacturing operations performed in Mexico were sufficient to result in a substantial transformation under the NAFTA Marking Rules but not under the traditional substantial transformation test). Therefore, companies that are moving manufacturing operations out of China and would prefer having the additional certainty that an objective substantial transformation test provides in determining the required level of non-Chinese processing needed to achieve a non-Chinese country of origin, should consider whether the NPRM presents new opportunities and, if so, whether filing a comment is appropriate.
• Implementation of the NPRM would result in the United States’ applying a different substantial transformation standard for non-preferential duty and certain government procedure purposes to goods from Canada and Mexico than it applies to goods from all other countries. For example, while manufacturing operations to produce a specific product in Mexico may be sufficient to result in a substantial transformation under the NAFTA Marking Rules, performing those same operations in a non-USMCA country (e.g., Vietnam) may not be sufficient to result in a substantial under the traditional substantial transformation test. From a domestic law standpoint, the legal basis for the U.S. adopting this different treatment is not clear as, unlike NAFTA, the USMCA is silent on non-preferential country of origin determinations, and even under NAFTA, these differences did not affect economic interests, such as duty and qualification for certain government procurement. In addition, treating Canada/Mexico differently than other countries may not be consistent with the U.S. government’s obligations under the World Trade Organization (WTO) Agreement on Rules of Origin, which requires that rules of origin not discriminate among WTO members, among other requirements.
• The NPRM highlights longstanding problems associated with the subjective nature of the traditional substantial transformation test; yet CBP continues to apply this test for nearly all non-preferential origin determinations. As such, to the extent companies would prefer an objective substantial transformation test (like the NAFTA Marking Rules) to apply more broadly than to imports from Canada and Mexico, the NPRM provides an opportunity to comment in support of this. While CBP proposed to do this on at three prior occasions, the trade community objected to the proposals at that time (it would likely have required companies to re-evaluate the origin of most of their product lines, potentially resulting in implementation costs related to packaging and duty changes). Having lived with the rules for longer now, and having experienced the challenges of potentially different origin determinations for marking and duty purposes, and given the increased certainty associated with the NAFTA Marking Rules versus the subjective traditional substantial transformation test, many in the trade community may be eager to accept such a change.

In summary, the proposed amendments would benefit companies adversely affected by two different non-preferential rules of origin applying to the same product and may benefit companies that are moving manufacturing operations in response to the China Tariffs (by, generally, decreasing the amount of operations that would need to be moved in order to achieve a non-China country of origin and providing greater certainty as to the minimum amount of production required outside of China). Companies that stand to be affected by the NPRM should consider submitting comments. The comment submission deadline is August 5, 2021.

¹ 86 Fed. Reg. 35,422 (July 6, 2021) (https://www.govinfo.gov/content/pkg/FR-2021-07-06/pdf/2021-14265.pdf).
² The NAFTA Marking Rules are codified in part 102 of the CBP Regulations (19 C.F.R. part 102). Although the NAFTA Implementation Act was repealed by the United States-Mexico-Canada Trade Agreement (USMCA) Act as of July 1, 2020, and the USMCA is silent on country of origin marking requirements, the part 102 rules remain applicable for country of origin marking determinations for goods imported from Canada or Mexico under the USMCA pursuant to an interim final rule (IFR) published in the Federal Register on July 6, 2021. The IFR codifies CBP’s practice of continuing to apply the NAFTA Marking Rules as of July 1, 2020, to provide a more seamless transition to the USMCA (see, e.g., Headquarters Ruling Letter H316281 (March 18, 2021)).
³ See 86 Fed. Reg. 35,422, 35,423 (July 6, 2021).
⁴ The NPRM would not affect origin determinations by other agencies, such as the Department of Commerce’s scope determinations in antidumping or countervailing duty proceedings or determinations by the Agricultural Marketing Service under the Country of Origin Labeling law or origin determinations made by other agencies for purposes of government procurement under the Federal Acquisition Regulation.
⁵ CBP adopting the amendments in the NPRM is not a foregone conclusion. Specifically, CBP has unsuccessfully attempted to replace the traditional substantial transformation test with more objective rules on at least three occasions (see 73 Fed. Reg. 43,385 (July 25, 2008); 56 Fed. Reg. 48,448 (September 25, 1991) and 59 Fed. Reg. 141 (January 3, 1994)).