Introduction

On January 1, 1994, the North American Free Trade Agreement (NAFTA) was officially implemented. One of the main benefits of the Agreement is the elimination of tariffs between the countries on all qualifying goods by the year 2003. NAFTA creates a free trade area, not an economic union market, such as the European Union. Therefore, customs administration will still exist, and in a country like Mexico (which still depends largely on customs’ duties to help run its government), the customs activity has been and will continue to be intensive. You must comply with the NAFTA regulations and the countries’ import regulations in order to take advantage of the market. By satisfying your customers, you can gain a foothold into one of the most exciting and rewarding export opportunities available today.

NAFTA was intended for not only Canada, Mexico and the United States; eventually all Latin American countries will be invited to join. Thus, companies that are currently involved in exporting to NAFTA countries increase their ability to be internationally competitive in the future, when all or most of the Latin and South American countries will also be "playing by the same rules."

The primary objectives of NAFTA are detailed in the Agreement’s principles and rules. These include the following key points:

• Eliminate trade barriers and facilitate the cross border movement of both goods and services between the NAFTA countries.

• Promote conditions of fair competition in the free trade area.

• Increase substantial investment opportunities within the territory.

• Provide protection and enforcement of intellectual property rights in each party’s territory.

• Create fair and amicable solutions to resolve disputes within the application and administration of the agreement.

• Establish a framework for further trilateral, regional, and multilateral cooperation to build on the benefits of NAFTA.

How are the tariffs going to be phased out?

The NAFTA will eliminate tariffs on almost all goods that originate in the United States, Canada, and Mexico. Origination is an important term in regards to duty free status. Origination within the Free Trade Area means that the product in question has been determined to have been manufactured within the NAFTA Area.

The United States and Canada, at NAFTA's inception, were already well into their own tariff elimination process as part of the U.S. Canada Free Trade Agreement. This process will continue as planned so that all U.S. and Canadian trade will be duty free by 2003. For most Mexican, Canadian, and U.S. trade, the NAFTA either eliminated existing customs duties on January 1, 1994, or will eliminate them in the next five to ten years after this date. (On some tariff sensitive food items, the Agreement will phase out tariffs over fifteen years.) The NAFTA countries may agree to either slower or faster phase-outs of tariffs as the Agreement progresses.

Are the NAFTA rates of duty the same?

Rates of duty will vary depending upon in which NAFTA country the goods were produced during the transition period. For example, the United States may apply a different rate of duty on a product entering from Canada than it would on the same product from Mexico. There are three NAFTA rates of duty for goods entering into Canada. The rates of duty will depend on whether the goods are of United States origin, Mexican origin, or are the result of a joint venture between the United States and Mexico. In order to find out which rate of duty applies, exporters and importers must first establish whether the goods meet the NAFTA Rules of Origin and then use the tariff rules found in annex 302.2 of the NAFTA. The Rules of Origin are the exercises one must use to test whether or not the product qualifies as originating in the North American free trade area. If originating, the product qualifies for preferential treatment from duties and taxes.

What are the NAFTA Rules of Origin?

NAFTA grants preferential status to a variety of goods within the region. Maximum benefits are reserved for goods that qualify as originating within the region. Originating is a technical term used to describe those goods that meet the requirements of Article 401 of the NAFTA. Article 401 of the Agreement establishes which goods originate in the region and prohibits similar goods from other countries from obtaining preferential duty status by being shipped through Canada, Mexico, or the United States.

What is so important about "Article 401"?

Article 401 of the agreement defines originating in four ways:

1. Goods wholly obtained or produced in the NAFTA region.

2. Goods produced in the NAFTA region wholly from originating materials.

3. Goods meeting the Annex 401 origin rule.

4. Unassembled goods and goods classified with their parts which do not meet Annex 401 rule of origin but contain 60 percent regional value content using the transaction method, or 50 percent regional value using the net cost method.

What defines "Wholly Obtained or Produced"?

Goods wholly obtained or produced entirely in Canada, Mexico, or the United States contain no foreign materials or parts from outside the NAFTA territory. Article 415 of the NAFTA defines goods wholly produced in the region as:

A. Mineral goods extracted in Canada, Mexico, or the United States. For example, silver mined in Mexico is originating because it is extracted in the territory of one of the parties.

B. Vegetable goods are defined in the Harmonized System as goods harvested in Canada, Mexico, or the United States. For instance, wheat grown in Canada is considered originating because it is harvested in the territory of one of the parties. The Harmonized System (HS) is the harmonized commodity description and coding system and its legal notes, which has been adopted and implemented by the parties in their respective tariff laws, providing measures for any law, regulation, procedure, or requirement in practice.

C. Live animals born and raised in Canada, Mexico, or the United States.

D. Goods obtained from hunting, trapping, or fishing in Canada, Mexico, or the United States.

E. Fish, shellfish, and other marine life taken from the sea by vessels registered or recorded with Canada, Mexico, or the United States and flying its flag.

F. Goods produced on board factory ships from fish, shellfish, and other marine life provided such ships are registered with and flying the flag of a NAFTA country.

G. Goods taken by Canada, Mexico, or the United States, or a person of these countries from the seabed or beneath the seabed outside territorial waters, provided that Canada, Mexico, or the United States has the right to explore such a seabed.

H. Waste and scrap derived from production within the Free Trade Area or used goods collected in the region, provided such goods are fit only for the recovery of raw materials.

I. Goods produced in Canada, Mexico, or the United States exclusively from any of the goods listed in paragraphs A through I or from their derivatives at any stage of production. For example, silver jewelry made in the United States from silver mined in Mexico is wholly obtained or produced in NAFTA territory because it is made exclusively of mineral goods extracted from Mexico.

What is "Annex 401 Origin Criterion"?

Article 401(B) indicates that goods may originate in Canada, Mexico, or the United States, even if they contain non-originating materials. The materials must only satisfy the rule of origin specified in Annex 401 of the agreement, which has been established for each Harmonized Tariff number.

The Annex 401 rules of origin are commonly referred to as specific rules of origin and are based on a change in Harmonized Tariff classification, a regional value content requirement, or both. Since Annex 401 is organized by the Harmonized Tariff Schedule (HTS) number, an exporter or importer must know the HTS number of a good, and the HTS numbers of all the non-NAFTA materials used to produce the good. The specific rule of origin must be interpreted to determine if the rule has been met. Annex 401 provides the applicable rule of origin opposite each HTS number.

What is a "Tariff Change"?

When a specific rule of origin is based on a change

Example: Frozen pork meat (HTS 02.03) is imported into the United States from Hungary and combined with spices imported from Jamaica (HTS 09.07-09.10) and cereals grown and produced in the U.S. The resulting product is pork sausage (HTS 16.01). The Annex 401 rule of origin for HTS 16.01 states: "A change to heading 16.01 through 16.05 from any other chapter". Since the imported meat is classified in chapter 2, and the spices are classified in chapter 9, these non-originating materials meet the required tariff change. You don't need to consider whether the cereal meets the applicable tariff change since it is originating. Only non-originating materials must undergo the tariff change.

in tariff classification, each of the non-originating materials used in the production of the good must undergo the applicable change. This means that the non-originating materials are classified under one HTS number prior to processing and classified under another after the processing is completed. The specific rule of origin in Annex 401 defines exactly what change in tariff classification must occur for the goods to be considered "originating."

What defines "Regional Value Content"?

Some of the Annex 401 specific rules of origin require that the goods in question have a minimum regional value content. Regional value content (RVC) is defined as a percentage of the value of the goods that must be from North America. Article 402 provides dual formulas for calculating the regional value content, which may also be referred to as the RVC. In general, the exporter or producer may choose between the transaction value method formula and the net cost method formula.

Having two RVC options allows producers or exporters the opportunity to satisfy the rule of origin when goods are not wholly obtained or produced within the free trade region. The transaction value method is generally simpler to use but a producer may choose whichever method is more advantageous.

How do you define "Transaction Value Method"?

The transaction value method calculates the value of the non-originating material as a percentage of the General Agreement on Tariffs and Trade (GATT) transaction value of the good. GATT is a postwar international organization created to set rules on trade to ensure non-discrimination, settlement of disputes, and the participation of less developed countries in international trade. The main tools GATT uses to increase trade consist of tariff concessions in which member countries agree to limit the level of tariffs they will impose on imports from other GATT members.

In addition, the Most Favored Nation (MFN) clause calls for each member country to grant every other member country the most favorable treatment it accords to any country with respect to imports and exports. The GATT transaction value of the good is based on the principles of the GATT customs valuation code with adjustments for packing and other items. The essence of this method is that the value of the non-originating materials can be calculated as a percentage of the invoice value, which is usually the actual price paid for the goods. Under the transaction value method, the producer is allowed to count all of its costs and profit as territorial, which is why the required percentage of RVC is higher (60%) than under the net cost method (50%).

Due to variables including the higher percentage of RVC, there are situations where the transaction value cannot be used and the net cost method is the only alternative. The net cost method must be used when there is no transaction value, in some intercompany transactions, for certain motor vehicles and parts. The transaction value method results in an unfavorable result for preferential treatment under the NAFTA.

The formula for calculating the RVC using the transaction value (TV) method is:

RVC = TV - VNM x 100
                     TV

RVC is the regional value content expressed as a percentage.

TV is the transaction value of the good adjusted to an F.O.B. (free on board) basis. Free on Board (FOB) means regardless of the mode of transportation, at the point of direct shipment by the exporter to the importer.

VNM is the value of non-originating materials used by the producer in the production of the good.

What defines "Net Cost Method"?

The net cost method calculates the regional value content as a percentage of the net cost to the manufacturer of the product. Net cost represents all of the costs incurred by the producer minus expenses for sales promotion (including marketing and after sales service), royalties, shipping and packing costs and non-allowable interest costs. The percentage content required for the net cost method is lower than that of the transaction value method because of the exclusion of certain costs from the net cost.

The formula for calculating the regional value content using the net cost method is:

RVC = NC - VNM x 100
                    NC

RVC is the regional value content expressed as a percentage.

NC is the net cost of the good.

VNM is the value of non-originating materials used by the producer in the production of the good.

How does one interpret "Produced in the NAFTA Territory Wholly of Originating Materials"?

Goods also originate if they are produced entirely in Canada, Mexico and/or the United States exclusively from materials that are considered to be originating according to the terms of the agreement.

What about Unassembled Goods and Goods Classified with their Parts?

There are two circumstances where the provision may be used when goods do not undergo the tariff change required by Annex 401:

1. The goods are imported into Canada, Mexico, or the United States in an unassembled or a disassembled form but are classified as assembled goods pursuant to general rule of interpretation 2A of the Harmonized System, or
2. The goods produced use materials imported into a NAFTA country that are provided for as parts, are classified in the same subheading or undivided heading as the finished goods.

What is the NAFTA Certificate of Origin?

The NAFTA Certificate of Origin, also known as Customs Form 434, is required of all exporters to Canada or Mexico in order to claim preferential tariff treatment under the North American Free Trade Agreement (NAFTA).  The document, which is presented to customs, helps the buyers avoid paying tariffs (duties) or pay the lowest tariff available under the agreement.

The NAFTA Certificate of Origin may be completed in English, French or Spanish.  At the exporter's discretion it should be completed in the language of the origin or destination country. Importers shall submit a translation of the certificate to their own customs administration when requested. An understanding of and competency in the harmonized system and the NAFTA Rules of Origin are imperative for an exporter to legally and correctly prepare the documents.

Exporters can prepare a blanket certificate, as long as the products that are being exported in a 12-month period are listed. The Certificate of Origin must be signed and completed by the exporter of the goods.  When the exporter is not the producer, the exporter can complete the certificate on the basis of: knowledge of the goods' origin; reasonable reliance on the producer's written representation; or a Certificate of Origin signed by the producer and voluntarily provided to the exporter. 

The NAFTA Certificate or Origin is not required when the goods do not qualify for NAFTA, based on the Rules of Origin or the fact that the goods were made outside North America.  The certificate is also not required when a commercial importation value is less than $1000.  However, if this is the case, companies still need to place a qualifying statement on their invoice that indicates that the goods are "originating" under NAFTA and that they are qualified under Annex 401. 

Copies of the document are available, complete with instructions, from http://www.customs.ustreas.gov/travel/forms.htm.    You can also look at our "List of Important Tips" to help you more accurately complete the Certificate of Origin.  

Does a producer who is not an exporter have an obligation to fill out this form?

The NAFTA does not obligate a producer who is not an exporter to provide the ultimate exporter of a product with a NAFTA Certificate of Origin. Many exporters, however, may request such documentation from their producers as proof that a good they sell to Canada or Mexico meets the Rules of Origin, or that input used in a good produced by the exporter meets a NAFTA Rule of Origin. If the non-exporting producer does complete the NAFTA Certificate of Origin, the producer is subject to the same obligations regarding record keeping etc., as the exporter.

Exporters or producers that prepare Certificates of Origin are obligated to provide them to their own customs administration upon request. Exporters and producers that complete a Certificate of Origin should also notify all parties to whom the certificate was given of any changes that could affect its accuracy or validity.

NAFTA Links

• NAFTA Institute
• Market Access and Compliance (U.S. Dept. of Commerce)
• Mexico-trade.com
• NAFTA Customs Web Site
• U.S. Customs Home Page
• NAFTA Implementation Resource Guide