Can Free Trade Agreements keep up with the increasingly complex and changing global value chains? Can the preferential origin regime restrict firms’ ability to trade under preference?
A shorter version of the paper prepared for the RTA Exchange Policy Dialogue “Towards Inclusive Rules of Origin”, 21–22 November 2016. Published by the E15 Initiative (HERE).
Access to preferential import tariffs under free trade agreements (FTAs) is governed by rules of origin designed to be a non-tariff barrier to trade that prevents non-members from enjoying the preferential tariffs under FTAs. Goods which do not meet origin criteria cannot benefit from preferential tariffs under an FTA.
In practice, a company’s ability to trade under preference is subject to a number of conditions and requirements, in addition to fulfilling the origin criteria. Some of these requirements are contained in the text of FTAs. These are, for example, provisions concerning the documentary evidence that needs to be submitted in order to demonstrate compliance with rules of origin, or the required type of origin certificate and period of its validity. Others are operational and/or administrative in nature and relate to the local legislation or the interpretation of the origin provisions by the local customs authorities. These are, for example, the rules for obtaining an approved exporter authorisation or the requirement to provide a certain type of documentation at the time of import.
These requirements and provisions are referred to as the broader architecture of the preferential origin regime and can inadvertently act as the second layer of restrictions to preferential trade in addition to the first deliberate layer – the rules of origin.
The preferential origin regime can restrict firms’ ability to trade under preference. It can prevent companies, whose products meet the rules of origin, from being able to benefit from preferential rates, leading to increased cost, increased lead time and loss of competitiveness. This is particularly relevant for firms with fragmented and highly dynamic global value chains (GVCs).
Multinational companies operating within GVCs adopt various operating models to reflect internationally fragmented production networks and supply chains and to take account of direct and indirect tax considerations. Digitalisation has also enabled small and medium-sized enterprises (SMEs) to trade under more complex and fragmented business models and to increasingly integrate into GVCs. As a result, they often face the same challenges as larger firms when it comes to operating under the broader preferential origin regime and are impacted by its restrictive nature.
One of the most common reasons for a refusal to grant a preferential tariff is the inconsistency of the origin, customs, commercial and transport documentation. When submitting an import declaration and claiming preferential import tariffs, a number of additional documents are required; for example, a commercial invoice, a bill of lading, an air waybill and a packing list. All these documents, as well as the origin documentation and import declaration, need to be consistent in the way in which they describe the goods, their quantity and weight, origin, and the port the goods were shipped from etc.
For firms with GVCs this can be particularly challenging as the flow of goods and the flow of invoices are often separated. For example, under a centralised principal model, it is often possible to have multiple invoices between the moment when the goods leave the manufacturing facility and when they reach the country of destination while the physical goods move directly from the toll manufacturer to the final customer.
Third-party invoicing provisions allow the goods to be invoiced by a company from a non-FTA country or via a company established in an FTA territory other than the exporter. When third-party invoicing is not explicitly allowed under the text of an FTA, the local customs authorities can request to see one invoice covering the entire transaction. In addition to being an administrative burden, such requests are often difficult to fulfil for commercial reasons. Each of the invoices includes a profit margin or mark-up which is often commercially sensitive.
In such cases the additional cost and time necessary to meet the administrative and procedural requirements as well as the increased administrative burden and compliance risk of trading under preference can lead companies that are able to meet origin criteria to trade under full import tariffs.
The preferential origin regime can therefore act as an additional barrier to preferential trade for companies with internationally fragmented production networks. This impacts the functioning of GVCs and the utilisation rates of FTAs.
The origin regime should reflect the increasingly complex and changing supply chains and operating models by promoting harmonisation and simplification of the operational and administrative requirements at the point of import and export. The interpretation of origin requirements should not be left to the local customs official at the point of import but should be addressed at the broader FTA or multilateral level.
On an FTA level, further guidance for local customs officials could be introduced either within the text or through the joint committees set up under most FTAs. Provisions for facilitating the movement of goods once the origin criteria have been met are included in the text of many FTAs. For example, the Pan-Euro-Mediterranean convention, the Canada-EU FTA or the Singapore-China FTA state that minor discrepancies between the origin and commercial documentation should not lead to the invalidation of the origin certificate. This could be extended to include further clarification on the interpretation of the origin regime under specific conditions resulting from internationally fragmented production. Similar provisions together with provisions allowing for third-party invoicing could help to facilitate preferential trade.
On a multilateral level, organisations governing global trade, such as the World Trade Organisation and the World Customs Organisation, can promote harmonisation of the origin regime by developing best practices for its interpretation and for the simplification of the procedural and administrative requirements for demonstrating origin.