For a quarter of a century, the North American Free Trade Agreement (NAFTA) has been both the most used and most controversial of America’s various trade agreements. But it will come to an end on July 1, 2020, to be replaced (barring some unlikely last-minute delay) by the new United States-Mexico-Canada Agreement (USMCA).
Are you directly affected by this change — either in your own business or your employer’s? After three years of slow progress as it moved through the negotiation and legislative processes, the April 2020 announcement of a midsummer 2020 implementation was unexpected. For many companies, this short window doesn’t offer enough time.
That’s why it’s essential to get up to speed quickly and learn how it affects your business and your customers.
How Trade Agreements Affect You & Your Customers
Reciprocal free trade agreements (FTAs) like NAFTA and USMCA are treaties between two or more countries designed to encourage domestic companies to increase their in-country sourcing and manufacturing. They reward them with reciprocal duty-free benefits if they do (and deny them these duty breaks if they don’t).
Let’s say you manufacture upholstered wooden chairs in the U.S. and sell them online. Canadian and Mexican importers typically pay their governments roughly 10% in import duties on upholstered wooden chairs, so they need to know whether the products qualify for NAFTA. If you can honestly tell them they do, then they can import your chairs duty-free, essentially knocking 10% off their bottom-line cost and making your chairs more competitive.
But even if you don’t export anything yourself, domestic companies can also export your products. So even companies across the street need to know if it qualifies for NAFTA if they resell your goods to their own foreign customers. Such resellers sometimes just assume you can issue a NAFTA certificate. They’re often downright shocked that you can’t.
The U.S., Canada, and Mexico are huge trading partners, ranking in each others’ top five markets for both imports and exports. Over the past 25 years, proper use of this program has saved thousands of companies millions of dollars in import duties.
The program has simultaneously helped countless additional vendors and employees since that’s the whole point of the program — getting exporting manufacturers to source more of their materials from domestic suppliers than they otherwise would, and to source more labor at home rather than abroad.
But it has also created confusion. Schools don’t teach trade compliance. And for 25 years, lots of people have just assumed NAFTA benefits automatically applied to everything that crossed the borders — discovering their mistake only after painful Customs audits, prosecutions, and penalties.
The USMCA updates NAFTA and makes up for some of its failings by bringing it up to date in areas of intellectual property protection and financial standards. It also increases the thresholds for some classes of products and enforcement — all so the original goal of using the program to increase domestic production is really easy to achieve. Finally, eliminating the old seller’s NAFTA certificate of origin and ostensibly putting the documentary burden on the buyer changes the way you manage and audit compliance.
The Rules of Origin
To qualify under an FTA, the product has to have been grown or made (not just tested, finished, or repackaged, but truly manufactured) in one of the FTA’s member countries. It must also be shipped directly between them without clearing Customs in any outside country.
The vendor then has to analyze its product to see if it qualifies.
If a product is grown domestically and all the materials are domestically produced — such as cheese made in a local dairy from local milk or wine made from locally grown grapes — then it’s all easy. Being 100% domestic in origin, the product qualifies.
But if the product is a combination of parts — some components of domestic origin and others imported — then you must read the rules of origin and perform whichever tests it allows for that product. You do that by reading the treaty itself and looking up the product’s harmonized tariff code (HTS).
Every HTS code has its own rules — which differ from FTA to FTA. Both in the existing NAFTA program and the new USMCA, they offer anywhere from one to four different tests, known as de minimis (or “tariff shift”) tests or regional value content (RVC) tests, the primary ones being the RVC-net cost (RCV-NC) and RVC-transaction value (RCV-TV) tests. These tests account for the mix of imported and domestic materials in each product and each material’s cost, origin, and HTS code. They also consider the manufacturer’s labor and equipment costs and sometimes the upper management and profit as well. These figures vary from sale to sale as sale prices change.
Once the vendor can prove a product passes one of the tests allowed for its product and is confident its claim can stand up to a Customs audit, it can issue a certificate of origin. If it cannot, then its customer must pay the duties and cannot make an FTA claim.
The USMCA Addresses NAFTA’s Shortcomings
Ever since the beginning, there has been a fear FTAs, especially NAFTA, don’t do enough to further the goal of bringing sourcing and labor back to North America. Too many manufacturers big and small have shut their doors only to be replaced by overseas (mainly Chinese) manufacturers. Despite the best intentions of FTAs like NAFTA, more and more of the components we import to make our finished products now come from abroad.
The USMCA hopes to reverse that trend. Lawmakers hope it provides greater encouragement to factories in the U.S., Canada, and Mexico to find domestic sources for more parts so their finished products again serve to employ more domestic workers.
The USMCA attempts to do that by reeducating the manufacturing world, reemphasizing the standards for qualification, and setting some new requirements in certain areas, particularly automotive and textile. In exchange for this added work, the agreement broadens certain benefits for agricultural products. It also eases the de minimis test by increasing the allowable percentage of nonqualifying components from 7% to 10% of the ex-works (EXW) sale price.
Now you just have to make sure your process is compliant by July 1, 2020.
10 Things to Do Today
Just like NAFTA, the USMCA is a massive body of regulations, and building a complete compliance program in a few weeks is likely impossible. But starting from scratch shouldn’t be necessary. Hopefully, you can update your existing FTA process to meet the needs of NAFTA’s replacement by focusing on these 10 key steps.
1. Determine Whether the USMCA Affects You
Begin by thinking about your business. Do you buy any physical goods made in the U.S., Canada, or Mexico, either as finished products for resale or as materials for things you make yourself? Do you ship anything at all to or from a location in the USA, Canada, or Mexico?
If not, this change might not affect you at all. NAFTA only dealt with goods manufactured, grown or mined in North America. And the USMCA is just as limited. If you don’t deal in physical goods or only import from non-North American countries, then the North American FTAs are likely irrelevant — unless you have customers who have been assuming your products qualified for NAFTA all along, in which case you need to correct them.
But if you do buy and sell physical goods of U.S., Canadian, or Mexican origin, then yes, you need to consider how the change affects your business. If purchased goods qualified for duty-free treatment before, you need to determine whether they still qualify. If they didn’t, but only barely failed the tests, it makes sense to check to see if they will qualify under the new version.
This change probably won’t significantly affect any service that buys local materials and sells exclusively locally to end consumers, such as restaurants, lawn care services, bankers, or dry cleaners.
FTAs primarily affect people who either buy and sell globally or sell to distributors who resell globally and therefore have customers who count on these duty-free benefits.
2. Check With Vendors Whether the Changes Affect Their Certifications
If you currently receive NAFTA certificates, statements, or declarations from any of your vendors today, you cannot just assume they’ll continue to be valid after July 1. Send a brief request to all current vendors asking them whether the change from NAFTA to USMCA will impact any NAFTA certification they’ve provided in the past and whether anything they sell you will lose or gain qualification with the new rules of origin.
Some companies are sending out fresh certification requests as though it were time for the regular annual vendor origin solicitation. You must do that each year anyway, typically in the late autumn. Even if you don’t choose to attempt a full new solicitation, dealing with the issue by exception management must be a minimum step. By requiring vendors to respond, you provide yourself some protection in case Customs finds any problems in a future audit.
Besides, you could always discover something you didn’t expect. Most companies change at least some of their sources from year to year. Some vendors you thought were selling you materials made in the U.S. may have switched to foreign sources years ago and you never noticed.
3. Review Your Own Products’ Qualifications Under USMCA
If you currently provide NAFTA certificates or declarations, you need to review whether your products still qualify.
If you just buy and resell — so you’re not doing any manufacturing yourself — it might be easy. You could never properly issue these declarations in the past without confirmation from your vendors that they qualified, so now you just need to see if your vendors’ qualification remains in place. Your vendors’ declarations — or their positive reply to your update request — are your supporting documentation for the declaration you issue to your customers.
But if you’re manufacturing, processing, or otherwise altering purchased goods, you must always analyze the product yourself before you can issue a certification to your customers. Check the rules of origin on your products and see if they have changed at all in this transition. Then, considering your vendor responses and whether your prices have changed, you may need to redo some or all of your analyses before you can issue anything to your customers.
4. Do Your Analysis
When you make something yourself, there are two overarching ways your product may qualify — either based on a calculation involving the sale price or not.
If the test involves the sale price (that’s the RVC-TV or de minimis tests in NAFTA or USMCA, plus the build-up and build-down tests in most other FTAs), then every time a sale price changes, your qualification could change.
The NAFTA-style group of FTAs (the agreements in Asia and the Pacific) has a couple of tests that reward you for profits. The higher your final EXW sale price, the more your profit counts toward qualification.
By contrast, the generalized system of preferences (GSP) group of FTAs (these are the ones the U.S. has in the Middle East, which are based on the GSP agreement) punish you for profits, so higher sale prices eventually kick a product out of qualification when selling to that group of countries.
If your price to a customer has dropped since the last time you analyzed it for NAFTA, then it could lose the benefit.
On the other hand, the change in calculation of the de minimis test — from only allowing 7% of untransformed non-NAFTA value materials to allowing 10% — could help some products that just failed before to just pass now. It is worth checking again.
The full qualification process is very complex, but let’s say you make a chair in the U.S. and sell it for $100. It’s made mostly from provably domestic wood, stain, and varnish but also with some imported European chair parts — cross braces and arms — that cost $8.50.
Since you were limited to 7% in untransformed non-NAFTA content before, that 8.5% of untransformed foreign origin would have stopped your $100 chair from qualifying for NAFTA. But with the new 10% allowance for such parts, the same chair at the same price now qualifies for the USMCA.
But that’s only for the tests based on the sale price. There are two situations in which qualification is based entirely on the materials and labor, so the sale price doesn’t play a role.
Lots of products are wholly originating, meaning 100% of the materials involved qualified under NAFTA from the start. In these cases, you don’t need any math or tests.
If you chop a branch off a tree in your yard for a wood carving or grow vegetables on your farm and sell them by the bushel, there are no imported materials at all. It automatically qualifies — always has and always will.
Net Cost Method
When this particular RVC test is allowed (and it isn’t always), it’s based on purchased materials, labor, and plant equipment (though not on upper management costs and profit). That means if the product passes the net cost test, changes in your outbound sale price don’t matter. This rule hasn’t changed in the new agreement. As long as the purchased materials that qualified before still do and the math hasn’t changed, you don’t need to redo this test.
So, the key here is to know how your products qualify. It’s common in the U.S. for the same company to make some products that qualify and some that don’t. Every bill of material has a different mix of components. Every product has a different price point, and every different HTS code has different rules of origin allowing different tests.
You might be allowed to try three or four tests for a product, or you might only be allowed to perform one. You need to know your process and go through it rigorously to protect both yourself and your customers.
5. Determine Whether You’re in a Targeted Group
In determining which big changes to make, the negotiators focused on three primary areas of importance, both economically and politically: agriculture, automotive, and textiles.
In agriculture, the new agreement opens up markets, particularly in Canada, to allow in more U.S.-originating dairy products. It’s a very narrow area, but if your business produces agricultural products in the U.S., investigate whether you have new markets thanks to the USMCA.
Canada is dropping or eliminating many product quotas and high import tariffs on multiple agricultural products, though much of it is gradual, over the next 10 years. Dairy farmers can expect to sell more poultry, eggs, milk and cream, and cheese to Canada.
The agreement takes a different approach to the automotive and textile sectors. Here, the primary concerns have long been the outsourcing of labor to companies that pay unfairly low wages and that by taking advantage of transformation rules, products could qualify for NAFTA with very little actual North American content.
The USMCA now requires that vehicles include 75% North American content to qualify (an increase from 62.5% in NAFTA). At least 70% of the glass, steel, and aluminum in a vehicle must be North American too. And there’s a complex new labor value content requirement that at least 30% of the work performed on an automobile be done by workers with an average pay of at least $16 per hour (this further increases to 45% by 2023).
If you’re currently a manufacturer, importer, or exporter in the automotive sector, that creates both a need and an opportunity for you.
- The need is to confirm with your vendors that they will still qualify for the USMCA, which will be complicated for some of them, and
- The opportunity is that you now have a stronger case to make to potential customers, as all North American automakers are now scrambling to increase their North American content. Whatever parts you make — hubcaps, door handles, sun visors, gearshift knobs, or dashboard burl, for example — might have been too expensive for automakers to consider before because they could buy cheaper ones from China. But now, they need to spend that much more money on North American content.
Manufacturers will find that many of the rules of origin have changed, with a difference in which tests are allowed and the thresholds required for passage. The new rules allow the use of textile inputs that are usually unavailable here (such as visible lining fabric and rayon fibers) while requiring the use of materials like domestic sewing thread, certain coated fabrics, and pocketing for products to qualify.
Every product has a different requirement. All importers and exporters — in these areas in particular — must carefully double-check their products’ HTS codes and the HTS chapter and section notes that govern them. Then they must review those codes’ specific rules of origin to be sure they understand the new qualification rules.
These are the primary areas they’ve heavily altered. But don’t assume your products aren’t affected if they aren’t listed here. Any rule could have changed, so double-check no matter what industry you’re in.
6. Learn the New Recordkeeping Rules
For 25 years, the primary legal obligation for the use of NAFTA rested with the exporter, who had to produce a NAFTA certificate for the importer to make a duty-free claim.
The USMCA joins many other FTAs in removing that legal obligation, placing the requirement on the importer instead. In theory, it’s the importer who has the documentary obligation when it makes its claim.
Arguably, though, that’s sleight of hand and doesn’t really alter your needs as a business. If importers want to claim the USMCA’s duty-free benefits safely, they need a paper trail that protects their claim when they get audited, as most importers eventually will.
The importer must get something in writing from its vendor — some kind of statement declaring which specific part numbers qualify. It may not have to be the same format as the NAFTA certificate, but it needs to include most of the same information.
Once issued, the vendor needs to be able to support that document. If the importer gets audited, Customs is sure to approach the supplier next.
So suppliers still need what they have always needed: declarations from their own vendors and their own bills of material or other worksheets showing which tests they performed and the math proving that the product passed. They also need the vendor invoices that contribute to the cost calculations, contracts or purchase orders, and work instructions or other International Organization for Standardization documents that establish the manufacturing process.
Like all import and export recordkeeping requirements, you must retain most such documentation in an organized manner for at least five years from the last date requiring the retention. That’s typically interpreted as seven years from creation, though Mexico has even longer retention requirements. And if duty drawback is a possibility, 10 to 14 years of retention is recommended.
Customs may never audit you or your customers. But if they ever do, you want your documentation to be readily available and so accurate the auditors decide to leave and look for easier pickings elsewhere.
7. Examine Your Intellectual Property Needs
The intellectual property (IP) provisions in the USMCA have received much of the press coverage. But they don’t significantly change how we do things in the U.S. For the most part, the change is that U.S. standards in the areas of copyright, trademark, and patents now extend across North America. For example, Mexico now has to protect copyright for the life of the author plus 70 years, establish a copyright safe-harbor law to deter online piracy, and provide at least 15 years of protection for industrial design.
It’s tempting to think that means it’s now safer to move patented products to other countries, but that’s too much of a leap. It’s never totally safe to give one’s IP to a foreign vendor. With the USMCA, it’s undoubtedly safer now. But don’t think all the risks of patent violations and knockoffs will suddenly disappear at midnight on June 30.
The safest approach — when possible — is always to outsource only things that aren’t secret and manufacture secret things yourself.
If your product has patents, trademarks, or copyrights, meet with your lawyer to see if your standard contract templates or customer- or vendor-generated contracts require any updates on these matters. Some companies have no IP issues at all, while others feel like half the contracts concern these issues.
Do you trade in licensed gear, clothing, or toys? Do you buy or sell books, videos, or music? Do you market anything bearing a logo or image from cartoon characters, sports teams, or famous brands or logos? If so, run your purchase orders and related templates past your lawyer too. You may need to update some terms to stay in sync with these new rules.
8. Update Your Legal Documents
You must update any template, whether for a contract or purchase order, that references NAFTA to show the USMCA instead. You can’t just assume contract enforcement automatically carries over any obligation linked to the old treaty.
If you have legal clauses anywhere that mention the old agreement, update those clauses to show the replacement and review documents to see if they create an obligation you need to investigate. You might have agreed to something in the past just because it was in a template, perhaps even unknowingly, and now you realize you can no longer meet such a commitment.
Many companies agreed years ago to always fill orders with NAFTA-qualifying goods because they only manufactured or sourced from the U.S. But in the intervening years, they grew, expanded their offerings, and broadened their sourcing, never realizing they were gradually falling further and further out of compliance with the old contractual obligations.
Now, you have a wonderful — and perhaps imperative — opportunity to do a refresh. It’s not just about changing out the old word for the new with a find-and-replace computer function. You must get back into compliance before the three governments’ new enforcement efforts kick in.
9. Communicate With Your Brokers & Forwarders
Some Customs brokers and freight forwarders are wonderful at managing and advising on the FTA process. Some of them have rigorous training and ensure that their staff is careful, helpfully guiding their clients in the direction of safe choices.
Unfortunately, some brokers and forwarders focus more on the transportation aspect than on the Customs side. They depend on an educated client base. There’s a reason the Customs Modernization Act established standards for reasonable care and informed compliance — to ensure businesses don’t put too much faith in their brokers and forwarders. Even the best broker or forwarder is only as good as the employee working on your account.
Many of the better brokers and forwarders, consultants, and trade-focused law firms are offering services like webinars and white papers to help companies handle the transition to USMCA. See if the ones you work with offer such services, and if so, take advantage of them.
To be safe, send out notices to your brokers and forwarders directing them not to assume USMCA qualification on either your imports or exports. Instead, they must check with you before making such claims to ensure there’s proper documentation in place to protect you and especially your clients when enforcement begins to ramp up. There’s no surer way to lose clients than by getting them in trouble with the government.
10. Update the IT System
The biggest companies have huge, expensive trade compliance bolt-ons, which can manage some information technology (IT) changes for you. But be sure to sign up for their training.
The smaller the company, especially for home and other small businesses, the more likely you need to manage these updates yourself.
For example, depending on what you have in place today:
- Creating a compliant USMCA declaration to replace the old NAFTA certificate
- Possibly updating your origin statements on outbound invoices
- If you store documentation electronically, reviewing and improving your retention process
- If you have built FTA qualification tests into your existing system, updating these formulas as appropriate, at least to change the de minimis test from 93% and 7% to 90% and 10%, but possibly much more
- Updating your annual vendor trade compliance request system to seek USMCA qualification data instead of NAFTA
- Checking standard documents like purchase orders, order confirmations, broker and forwarder cover letters, and shippers’ letters of instructions to see if you need to change NAFTA-related clauses or if you must add new USMCA clauses
- Checking or revising the item master in the enterprise resource planning system or other software if you capture or track NAFTA (now USMCA) status on purchased or sold items here
The USMCA is a complex treaty. Reach out to your brokers and vendors, read over the rules that apply to your business and products, and study the U.S. trade representative fact sheets to see if there’s anything else that relates to your situation. You can also get more information on the U.S. International Trade Administration’s and Customs’ USMCA resource pages.
Are you an importer, or an exporter, or both? Do you now know what to do next, or are these changes too overwhelming?