Friday, July 25, 2008

Goodbye Substantial Transformation, Hello Tariff Shift

Customs and Border Protection has published a Notice of Proposed Rule Making today proposing to do away with the time-honored substantial transformation test for determining country of origin. I'm sad. I like this rule. I like it for precisely the reasons that CBP wants to do away with it.

The substantial transformation rule states that merchandise originates from the country in which it last changed its name, character, or use. The first articulation of this test was in a 1908 Supreme Court decision involving Anheuser-Busch. The question was whether cleaning and coating beer bottle corks (!) produced U.S.-origin corks. The Court held that the corks remain foreign because no new product emerged from the operations in the U.S. The most famous substantial transformation case is U.S. v. Gibson-Thomsen (1940) in which the Court of Customs and Patent Appeals found that wooden brush blocks and toothbrush handles without bristles became articles of the U.S. when bristles were added.

This approach has given importers and their lawyers a fair amount of leeway in arguing over origin. Finding a name change is gold. When that fails, you need to look for more subjective changes in character and use. This has led to a variety of strategies including things like whether the imported merchandise is a "producer's good" as opposed to a "consumer's good."

As early as the NAFTA negotiations in the early 1990s, it was clear to some (I suspect mainly in Canada and Mexico) that this test was too unpredictable. As a result, NAFTA introduced the concept of tariff-shift based origin rules. Keep in mind that we are not talking about the preference origin rules of HTUS Note 12(t). For this purpose we are talking about the so-called NAFTA Marking Rules of 19 CFR Part 102.

In today's notice, CBP has pulled the trigger on its long-stated desire to apply the NAFTA Marking Rules across the board. The only exceptions will be where an international agreement requires the use of substantial transformation. So the preference origin rules under NAFTA will not change. Also not proposed for change are preference determinations for goods--other than textiles and apparel-- under the U.S.-Israel and U.S.-Jordan FTAs. For other FTAs and programs that rely on origin determinations, the Part 102 rules will apply in addition to the other requirements of the programs.

So, you might be wondering, what about the Generalized System of Preferences? Remember that the rules for GSP require a substantial transformation (or double substantial transformation for non-BDC materials) plus 35% value added and direct shipment. Under this proposal, the rule will be based on tariff shifts, 35% value added, and direct shipment.

At first blush, I'm not sure I see much to complain about here. In a case called Bestfoods, the Federal Circuit said that CBP has the legal authority to dispose of substantial transformation. And, from an administration perspective, this will likely produce more predictable results for importers. The real trouble, of course, will be in the implementation details. There are very likely to be pockets of importers who are suddenly going to have to mark as foreign products they have been selling in the U.S. without origin labels. Based on my experience, this will drive the marketing people nuts. It will take some time for those issues to surface. Now would be a good time examine your origin determination process and see what might change. Comments are due in 60 days on September 23, 2008.


Matt said...

Alas, with the demise of the terms of reference established by the 1908 Anheuser-Busch bottle cork case, we will never again get to ask the question raised in the classic SNL skit: does cork-soaking result in a substantial transformation?

Anonymous said...

Any suggestion how this will effect exporters from the US? Have the rules changed there too?

Larry said...

As far as I know, this is a US-only initiative. The WCO has been working on uniform rules since . . . well, forever. It is entirely possible that this effort by CBP is part of a broader strategy to kick the international process into gear. Back in the early 1990's the U.S. could not get the WTO to act on intellectual property rights. The U.S. decided to take what it wanted and negotiate it into NAFTA. The result proved to be a useful model for what eventually became the TRIPS agreement. Maybe something like that is going on here. But maybe I am just wildly speculating without any real basis. At least I admit it.

Anonymous said...

Does anyone have an indication of how this change will affect the Bearing industry as the substantial transformation of the races is a big thing for them?

Anonymous said...

Does anyone know how TAA applies to software developed in a non-compliant TAA country?