Michelle Schulz, co-chairwoman of Gardere International Practice Group.

There is little doubt that the North American Free Trade Agreement (NAFTA) needs updating since it entered into force in 1994. As the first round of the NAFTA negotiations among the United States, Canada and Mexico get underway in Washington, D.C. on August 16, 2017, it is not likely the negotiators will do away with the agreement altogether. US companies claiming preferential tariff treatment under NAFTA stand to lose significant duty savings unless the framework stays in place. In fact, Mexico and Canada are the top markets for exports from Texas. In 2016, Texas exported over $92 million in goods to Mexico and over $19 million in goods to Canada.

NAFTA eliminates U.S. import duties on most goods originating in Canada, Mexico, and the United States. The benefits are reserved for goods that “originate” within the NAFTA region as defined in Article 401 of the NAFTA. This limitation means U.S. Customs and Border Protection (CBP) will deny false NAFTA claims on non-qualifying goods, and importers must carefully review the regulations to ensure their claims are valid.

Goods can only qualify as originating in specific ways, such as:

1. Wholly obtained or produced within the NAFTA region (e.g., fish, wheat, minerals);

2. Produced in the NAFTA region wholly from originating materials;

3. Making a qualifying change in the product’s tariff code under NAFTA article 401(b) (tariff shift rule); or

4. Meeting a regional value content requirement (e.g., regional content of 60 percent, 50 percent, etc.)

For goods made in one country using domestic inputs, determining origin under NAFTA is not difficult. Where goods are manufactured in a NAFTA country using domestic and foreign inputs, determining whether the goods “originate” is more complicated. Many goods that are manufactured in one of the NAFTA countries can qualify as originating even if they contain non-originating materials (i.e., inputs made or produced outside the NAFTA countries). Under the tariff shift rule, for example, if the non-originating materials are classified under one tariff code before processing, but come under a different code on completion of processing, then the finished good qualifies as a NAFTA good. The specific rule of origin in Annex 401 of the NAFTA lists precisely what classification change must take place for an item to qualify as originating. The regional value content requirement means that a certain percentage of the value of the finished good must come from the NAFTA territory. Because the rules of origin are so technical in nature, importers routinely establish detailed procedures to substantiate their NAFTA claims.

Other ways to confer origin that are not one of the four criteria above include accumulation and de minimis. The concept of accumulation permits NAFTA origin where a good is produced in two or more locations in the NAFTA territory and the regional value content of both locations is aggregated (e.g., finished in Canada and incorporated into end-item in the U.S.). Under de minimis, NAFTA originating rules provide an exception to the tariff shift rule if the value of non-originating materials that do not qualify for the tariff shift is less than ten percent of the adjusted value of the good.

Exporters in the NAFTA region certify products as qualifying for preferential treatment via signed certificates of origin. To support NAFTA claims, U.S. importers must submit these certificates of origin to CBP on request. If a certificate of origin contains inaccurate information, the U.S. importer must correct it and pay the back duties owed. The U.S., Canada, and Mexico may impose criminal, civil, or administrative penalties for false NAFTA claims. Penalties can be up to the dutiable value of the merchandise, or multiples of the duties owed. Not too surprisingly, as customs and trade attorneys we sometimes encounter invalid NAFTA certificates. For example, we have seen NAFTA certificates for goods we know are 100% Chinese made.

If an importer can verify that a NAFTA claim in fact qualifies for duty free treatment, the duty savings can be exponential. For example, a beef importer could eliminate a 10% duty rate by importing originating high-quality beef from a NAFTA country under Harmonized Tariff Schedule of the U.S. (HTSUS) code 0202.30.30.00. Certain knitted or crocheted fabrics classified under HTSUS 6001.91.00.10 are normally subject to an 18.5% duty rate, but can be imported into the US free of duty if the fabric qualifies for NAFTA under the applicable rule of origin. (Note that determining origin for textiles can be especially complex where the article was cut, sewn, dyed, and otherwise made across multiple countries.) Making paper into corrugated paperboard can transform a product sufficiently to confer origin in a NAFTA country under HTSUS 4808. And while aircraft are usually duty-free, an importer could still save 3% on the parachutes if they are originating.

Reliance on NAFTA does not mean unfettered movement of goods between the U.S., Mexico and Canada. NAFTA duty savings is a privilege afforded to US importers whose products satisfy the NAFTA rules of origin. Because this privilege creates a revenue loss for the U.S. Government, CBP has strict regulations on claims for duty free treatment, with significant penalties for companies who fail to substantiate their claims. U.S. importers who make duty free claims under NAFTA have presumably taken into account not only the potential duty savings, but also the related costs and risks of compliance.

For those importers who understand the NAFTA requirements and know how to comply, they have a competitive advantage over those companies who do not. Also, importers who rely on NAFTA are better positioned to take advantage of benefits under other free trade agreements.

Currently U.S. companies benefit from substantial savings with legitimate claims to preferential tariff treatment under NAFTA and other free trade agreements. As NAFTA renegotiation makes headway, importers who have made significant financial investments in their supply chains and import compliance programs remain acutely aware of the potential financial impact associated with any changes affecting their NAFTA claims. The hope is that those duty savings will continue. However, with the U.S. Trade Representative’s Trade Policy Agenda for 2017 emphasizing enforcement across the board, the top priority for many importers now is to verify those claims are valid.

Michelle Schulz and Elsa Manzanares are co-chairs of the International Trade Group at Gardere Wynne Sewell LLP in Dallas. Michelle Schulz is a cleared adviser who will be present throughout the first round of NAFTA negotiations in Washington, D.C.