APEC—Automotive Rules of Origin



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2005/ADSC/012

Agenda Item: 6

APEC Automotive Dialogue Automotive Rule of Origin Recommendations

Purpose: Consideration

Submitted by: USA

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| |14th Automotive Dialogue Steering Committee Meeting |

| |Yokohama, Japan |

| |18-20 October 2005 |

October 2005

APEC Automotive Dialogue

Automotive Rule of Origin Recommendations

Asia-Pacific Auto RoO Simplification/Uniformity

The ongoing proliferation of FTA is creating unnecessary complexity, costs and burdens

Rules of origin are used to establish eligibility for the trade preferences provided by preferential free trade agreements (FTAs). Not only do origin rules tend to vary among between different trade agreements, but the origin requirements for different products may vary within the same agreement. This represents a special challenge in the automotive sector, where regional value content (RVC) rules of origin in combination with “tariff shift” tend to predominate. Regardless of the methodology chosen, “tariff shift” tests and content-based rules require the development and maintenance of records and systems to verify that targeted levels of value or cost have been met within the free trade region. To the extent that products are exported to countries with differing rule of origin requirements, multiple systems to track content for different products will be required by automakers.

This situation also presents problems for the governments that must enforce multiple rules of origin at their borders. Not only must customs agents be trained to enforce each unique rule but the time to process customs transactions may be increased because of the added complexity of the rules. If customs agents are not adequately trained, there is a risk that non-qualifying products may be provided duty preferences, thus reducing legitimate customs revenues. The more FTAs with different and unique auto rules of origin methodologies, the more cost and bureaucratic burdens are placed on governments and automakers.

A uniform methodological approach to determine the origin of automotive product is the ideal

The use of a uniform methodology to determine automotive rule of origin for all FTAs in the APEC region would benefit governments, automakers and consumers by reducing the burden and cost of complying with and monitoring different rules. However, given the number of FTAs and auto RoO already in place, this objective is unlikely to be fully achieved.

Simplification and progress toward uniformity of rules of origin for automotive products is an objective for future FTAs

Given the benefits that can be achieved and the inefficiencies that can be avoided, progress towards a simpler and more uniform auto rule of origin for the APEC region should be attempted. Realistically, however, the goal of a single auto rule may never be achieved, given the number of FTAs already in place in the region and differences in opinion regarding the preferred type of rule. Therefore, the short-term goal would be to build a consensus about the recommended elements of a model(s) RoO to be used for future preferential free trade agreements, or for long-term reform of established FTA rules of origin.

Basic Tariff Shift/RVC Models

Tariff Shift

Many of the most recently concluded free trade agreements in the APEC region have relied, in large part, on the product-specific application of a “tariff shift” test to establish whether or not the criterion of “substantial transformation” has been met. When the “tariff shift” requirement is met, the product is considered “originating” and can enjoy the trade preference (e.g., duty free treatment).

In most cases and for most goods, shifting from one tariff category to another tariff category automatically indicates that a good should be considered “originating” from the country/region where the “substantial transformation” took place and thus enjoy an FTAs trade preferences. For example, when imported steel is stamped/modified into a motor vehicle body panel, it has experienced “substantial transformation” and in most all cases can be considered originating in the country/region where that transformation took place Tariff shift is a relatively simple and straight forward process that is preferred procedure for determining origin for many automotive parts/components.

However, for many automotive goods, particularly more elaborately transformed manufacturers, such as motor vehicles, engines, transmissions, etc., the basic “tariff shift” has been supplemented by an additional regional value content requirement. This is necessary for the more complex or elaborate manufactures, since almost all these products easily “tariff shift.” For example, under a pure tariff shift arrangement, all the major inputs for a motor vehicle (e.g., vehicle body, engine, transmission, etc) could be imported separately from outside of the FTA, and assembled into a motor vehicle—tariff shifting from auto parts tariffs to a motor vehicle tariff, and thus considered “substantially transformed”. Under this arrangement, the entire content of a vehicles, except the labor of assembly, could be considered “originating” and thus enjoy the benefits of the free trade agreement. Allowing this would undermine one of the primary purposes of a preferential free trade agreement—providing preferential benefits to the parties of the agreement, not to third parties. For this reason, a RVC requirement becomes necessary for certain automotive goods—to ensure that the good meets a certain minimum regional value content (RVC).

Regional Value Content

There are two leading auto RoO RVC methodologies in the APEC region—“cost” and “value.” Both these approaches, primarily used for determining eligibility for complex manufactures (e.g., motor vehicles and major components), are often added to the above description of “tariff shift” (see above).

A “cost” based approach to establish RVC for motor vehicles and parts is based on the production cost of a vehicle less the non-originating materials. This approach is used in the NAFTA. The recently concluded U.S.-Australia trade agreement also uses a “cost” test, although the approach has been simplified to eliminate a NAFTA requirement to trace the originating value in designated parts. Most of Mexico and Canada’s FTAs in the Western Hemisphere also use a simplified “cost” approach.

The other leading type of RVC methodology used in the region is based on the total regional value added of the automotive product, know as “value” base rules of origin. These methods generally subtract the value of non-originating materials from a designated “total” value added. FTAs that use this approach include the ASEAN FTA, Japan-Singapore, Japan-Mexico, U.S.-Singapore, U.S.-Chile FTA, and the Australia-Thailand FTA.

Under both of the basic “cost” and “value” models referenced above are equally difficult/easy to determine. In both, specific elements can be added or excluded from the calculations (e.g., interest, overhead, profits, selling expenses, etc.), and the rule of origin percentage threshold would be determined separately by the FTA partners, taking into account the economies’ auto market size, and auto industry level of development, etc. It is important to note a significant difference-- that “value-based” methodologies generally result in a higher content level than net “cost-based” approaches, because of the inclusion of profit, overhead and selling expenses. For example, if a “cost” (build-up) based rule of origin methodology with a RVC of 55% might be roughly equivalent to a “value” (build-up) based rule of origin methodology with a RVC of 35%.

The following are two basic “cost” and value” based auto RoO RVC models, with a build-up and build-down formula for both:

COST

The basic build-down methodology for the “cost” approach:

RVC = C – VNM x100

C

or,

The basic build-up methodology for the “cost” approach:

RVC = C x100

C + VNM

Where,

RVC – is the regional value content, expressed as a percentage

C – is the net cost of the good; and

VNM – is the value of non-originating materials acquired and used by the producer in the production of the good, does not include the value of a material that is self-produced.

In general the definition of “net cost” or “cost” for both the build-down and build-up approaches is as follows: Calculate the total cost of the goods produced by the producer, subtract and sales promotion, marketing, and after sales service costs, royalties, shipping and packaging costs, and non-allowable interest costs that are included in the total cost of all such goods, and then reasonably allocate the resulting net cost of those goods to the good.

VALUE

The basic build-down methodology for a “value” based approach:

RVC = V – VNM x100

V

or,

The basic build-up methodology for a “value” based approach:

RVC = VOM x100

V

Where,

RVC – is the regional value content, expressed as a percentage

V – is the adjusted FOB value of the good

VOM – is the is the value of originating materials; and

VNM – is the value of non-originating materials that are acquired and used by the producer in the production of the good.

In general the definition of “transaction value” or “value” for this approach is as follows: all expenses incurred in the production of the material, including general expenses (sales costs), profits, the costs of freight, insurance, packaging, and all other costs incurred in transporting the material to the location of the producer; duties, taxes and customs brokerage fees on the material paid in the territory of one or more of the parties, and the cost of waste and spoilage resulting from the use of the material in the production of the good.

Recommendation

Given the ongoing proliferation of FTAs in the Asia-Pacific region, the benefits to governments and industries of limiting the number of different types of automotive rules of origin, and the existence of several tried and tested auto RoO approaches, the Auto Dialogue panel of experts recommends that parties to future free trade agreements in the Asia-Pacific region look to the use of “tariff shift” combined with one of the two basic RVC models (outlined above) as models. Use of “tariff shift” combined with one of these two basic models will limit the number of different types of RVC models, lower the administrative costs and burdens on governments and industry, but allow for adequate flexibility (tariff shift application, RVC levels, build-up, or build-down, etc) to adapt to the different varieties of FTAs.

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