Rules of Origin

By Margaret M. Gatti, Esquire
(Article appeared in the 1999 Custom House Guide)
All Rights Reserved

The phrase "rules of origin" is comprised of three very simple words and on this basis, the phrase is deemed by many to represent a very simple concept. Indeed many jump quite readily to this conclusion and define "rules of origin" without a great deal of thought as the means for determining the place where a product is grown or produced. This conclusion is misleading, however, and unlikely to result in accurate origin determination for U.S. Customs purposes.

To accurately assess origin, it is first necessary to understand and acknowledge five fundamental issues. (1) Products today are often the result of production in several different countries which makes the determination of country of origin rather complex and somewhat artificial in any event. (2) The phrase "rules of origin" has many different definitions that vary on a product basis and that also vary among countries and within countries. (3) Despite various global and national efforts over the years to achieve a harmonized definition of origin rules, success had not yet been achieved and is not on the immediate horizon. The multinational effort to develop globally harmonized origin rules that is currently underway and that is operating under the auspices of the World Trade Organization failed to meet the July 1998 deadline that it had established for itself and was forced to compromise on a new target date of November 1999. (4) Correct application of origin rules is essential in assessing the relevant duties or tariffs to be imposed on imported products. It is also essential in gaining access to various preferential trade agreements that have been negotiated by the U.S. on a bilateral or multilateral basis. (5) Incorrect application of origin rules can expose an importer to monetary fines and other import penalties, such as entry delays and merchandise seizure.

This article will examine different definitions of the phrase "rules of origin" as currently used in the United States for import purposes. It will also recommend a methodology for determining the relevant rule of origin in specific situations.

The United States defines the country of origin for imported products in accordance with diverse definitions, including the general rules of origin, the rules of origin for textile and apparel products, various country specific rules of origin and various region specific rules of origin.

The general rules of origin currently define the country of origin for a good as the country in which a good is manufactured, produced or grown. Further work or material added to the good in another country must affect "substantial transformation" of the good in order to change the good. s country of origin. Substantial transformation means production which results in a new and different good, that has a name, character and use that is different from those of its constituent materials.

No statute or regulation specifically defines a test for substantial transformation and in general, substantial transformation is determined on an ad hoc, case by case basis. The case by case determination of substantial transformation more often than not produces incongruous and inconsistent results vis a vis the origin of specific products. As a result, the concept of substantial transformation has received considerable attention from the courts and is currently grounded in case law.

Although numerous attempts have been made over the years to make the concept of substantial transformation more predictable and less reliant on case law, little to no progress has been achieved to date and the general rules of origin in the U.S. are still based on substantial transformation.

The general rules of origin apply unless they are overridden by other prescribed rules of origin as in the case of the rules of origin for textile and apparel products, country specific rules of origin and region specific rules of origin.

The country of origin rules for textile and apparel products consist of five mutually exclusive rules that are applied sequentially in the order summarized below:

(a) the country of origin of a textile or apparel product is the single country in which the good is wholly obtained or produced; (b) alternatively, the country of origin of a textile or apparel product is the single country in which the foreign materials that are incorporated in the good undergo a designated change in tariff classification and \ or meet any other applicable tariff classification shifts as prescribed in the Customs Regulations; (c) alternatively, the country of origin of a textile or apparel product is the single country in which the good was knit if the good was knit to shape or the good was wholly assembled if the good was not knit to shape; (d) alternatively, the country of origin of a textile or apparel product is the single country in which the most important assembly or manufacturing process occurred; (e) alternatively, the country of origin of a textile or apparel product is the last country in which an important assembly or manufacturing process occurred.

Country specific rules of origin represent the results of special trading arrangements that the U.S. has made with individual countries. Generally these arrangements provide for preferential trade treatment by the U.S. either on a non-reciprocal basis (preferential trade treatment provided only by the U.S.) or on a reciprocal basis (preferential trade treatment provided both by the U.S. and by the country with which the U.S. has made special trading arrangements). Examples of preferential trading arrangements that the U.S. has made with other countries include the arrangements that the U.S. has made with the countries designated by the U.S. as countries eligible for the Generalized System of Preferences (designated GSP countries) and the arrangements that the U.S. has made with specific countries, like Israel.

The preferential trade arrangements made by the U.S. with designated GSP countries are non-reciprocal trade arrangements that provide for duty free entry into the U.S. of "qualifying goods". The function of origin rules in these trade arrangements, therefore, is to determine which goods constitute qualifying goods. These goods include: (a) goods that are wholly the growth, product or manufacture of a GSP designated country; and (b) goods in which the sum of the cost or value of the materials produced or substantially transformed in the GSP country plus the direct costs of the processing operations performed in the GSP country equal or exceed 35% of the appraised value of the good.

In contrast to the preferential trade arrangements made by the U.S. with designated GSP countries, the preferential trade arrangements that the U.S. made with Israel are reciprocal in that they provide for duty free entry of each other's "qualifying goods". The function of origin rules in the U.S.-Israeli trade arrangements, therefore, is to determine which goods constitute qualifying goods. These goods in the case of U.S. imports from Israel include: (a) goods that are wholly the growth, product or manufacture of Israel; and (b) goods in which the sum of the cost or value of the materials produced or substantially transformed in Israel plus the direct costs of the processing operations performed in Israel equal or exceed 35% of the appraised value of the good.

Region specific rules of origin represent the results of special trading arrangements that the U.S. has made with groups of countries or specific geographic regions. Like the country specific rules of origin, the region specific rules of origin provide for preferential trade treatment between and among the participating countries on either a non-reciprocal basis or on a reciprocal basis. Examples of preferential trading arrangements that the U.S. has made with specific geographic regions include the Caribbean Basin Initiative (various Caribbean countries), the Andean Trade Preference Act (Bolivia, Columbia, Ecuador and Peru) and the North American Trade Agreement or NAFTA (Canada and Mexico).

The preferential trade arrangements made by the U.S. in the Caribbean Basin Initiative and the Andean Trade Preference Act are non-reciprocal trade arrangements that provide for duty free entry into the U.S. of "qualifying goods". The function of origin rules in these trade arrangements, therefore, is to determine which goods constitute qualifying goods. The rules of origin for the Caribbean Basin Initiative and the Andean Trade Preference Act are basically the same as the rules of origin for preferential trade arrangements made by the U.S. with the GSP countries and Israel which are summarized above.

In contrast to the preferential trade arrangements made by the U.S. under the Caribbean Basin Initiative and the Andean Trade Preference Act, the preferential trade arrangements that the U.S. made under NAFTA are reciprocal in that they provide for duty free entry (or in some instances merely reduced duty entry) into a NAFTA member country of another NAFTA member country. s "qualifying goods". The function of origin rules in the NAFTA trade arrangements, therefore, is to determine which goods constitute qualifying goods. The NAFTA Rules of Origin define qualifying goods by specifying four mutually exclusive rules that are to be applied sequentially in the order summarized below: (a) the country of origin of a good is the country in which the good is wholly obtained or produced if: (a1) the good is comprised exclusively of domestic materials; or (a2) the foreign materials that are incorporated in the good undergo a designated change in tariff classification and additionally meet any other applicable Customs Regulations requirements related to required regional value content. (b) alternatively, the country of origin of a good is: (b1) the country of origin of the single material that imparts the essential character of the good; or (b2) a country which may be determined on the basis of an inventory management method if the material that imparts the essential character of the good is fungible or has been commingled and direct physical identification of the origin of the commingled material is not practical. (c) alternatively, the country of origin of a good is the country or countries of origin of all materials that comprise a good and that merit equal consideration for determining the essential character of the good, if the good is a set, a mixture or a composite good. (d) alternatively, the country of origin of a good is: (d1) the country of origin of each material that merits equal consideration in determining the essential character of the good, if the good was produced only as a result of minor processing; or (d2) the country of origin of the parts of a good when the good is produced by simple assembly and when the assembled parts merit equal consideration in determining the essential character of the good; or (d3) the last country in which the good underwent production.

Faced with diverse definitions of origin, a U.S. importer must develop a methodology for determining which rules of origin to apply in a specific situation. Obviously, an importer should first consider whether or not any product specific origin rules apply. If the importer determines that product specific rules are not applicable, the importer should then look to see whether or not any country specific rules of origin come into play. If neither product specific rules of origin nor country specific rules of origin apply to a specific import transaction, the importer should consider the applicability of region specific rules of origin. Only after determining that none of the above-referenced rules of origin have any bearing on a specific import transaction should an importer resort to the application of the general rules of origin.

Importers who remain uncertain as to the applicable origin rules to apply in any given situation have the option of submitting a written request to Customs for a pre-importation or advance ruling. Advance rulings are binding at all ports of entry in the U.S.