August 2020 Volume 2

WASHINGTON UPDATE

6. Will there be benefits/disadvantages by region – U.S./ Mexico/Canada? Mexico has picked up a lot of the benefit from the fallout between the U.S.-China relationship, and all of the low-value electronics commodities and other things like that are flocking to Mexico and not necessarily benefiting the U.S. or Canada. The U.S. and Canada may pick up some of this work because of the requirement for the 40 and 45% labor value content rule, but what we're seeing is that Mexico is going to have the biggest wins here. 7. Please confirm that the tariff for non-compliance to the USMCA regional value content and the labor value content rule is 2.5%. The USMCA is a free trade agreement and its purpose is to eliminate what is effectively the Most Favored Nation (MFN) tariffs that would normally apply under the United States harmonized tariff schedule (HTS) for imports of goods into the Customs territory of the United States. MFN tariffs apply to all imports regardless of source country. It’s only when you get into various free trade agreements that you alter those MFN tariffs. MFN tariffs depend on the type of product, classification, and valuation. Importers are responsible for using what Customs calls “reasonable care” to ascertain whether a particular tariff rate applies or not. The act of classifying the goods requires the importer to be very familiar with what it is actually importing and where in the HTS that import lies. Once you classify the good under a particular HTS subheading, the HTS provides a schedule of the duty. The operation of a free trade agreement essentially eliminates that duty, effectively reducing it to zero, provided that certain originating rules are followed. This free trade agreement is intended to expand the borders or the customs territory of the United States beyond the physical borders of the United States. That way, certain reciprocal trading relationships can form and effectively eliminate the tariff barrier. In the USMCA, how do you determine whether something is originating? This is the Rules of Origins section (chapter 4 of the agreement), which is very detailed on USTR’s website. The rules of origin are slightly different than under NAFTA, and what they're intended to do is incentivize production activities in the North American production sphere. What you have is basically a change in the regional value content. Keep in mind that a tariff that will apply – the standard tariff that would be subject to product if you were importing it from a country that that did not have a free trade agreement – if you don't satisfy the regional value content rules of the USMCA is. It’s not a penalty. It is, in fact, simply going back to the status quo ante of the free trade agreement. But if you follow the rules of origin requirements, what you actually would be able to do is to reduce the tariff burden and the talked-about 2.5% figure, because it's the easiest as it applies to passenger vehicles and specific categories of auto parts, but there's a lot of different types of products that may be used in an automobile that are classified elsewhere in the harmonized tariff schedule. The 2.5% may work for certain products, but it may be a different number for others.

8. Will the 2.5% tariff be enough to entice forge buyers to change their current supply-chain strategy? No doubt forging customers are currently studying localization, but will there be onshoring due to new USMCA guidelines? Initial assessments are that the 2.5% tariff was so low and the cost of compliance and bringing some vehicles up into compliance was so high that these new rules of origin would be non-binding and automakers would choose to pay the tariffs. They would be paying the tariff ad infinitum (again and again) – a stream of payments on the tariff and not just the 2.5% into the U.S., but 15% into Mexico 6.1% into Canada for vehicles. And, of course, they have different tariffs for their parts as well. Eliminating “deemed originating” is probably more important. Deemed originating was a designation that meant that anything not on the tracing list could just be said to be from North America. Getting rid of deemed originating may have more bite in moving supply chains than the higher rules of origin like the higher targets. There will be more trade that comes in not claiming the preferences (i.e., claiming more regular trade). Another complicating factor is that both Mexico and Canada are members of the CPTPP, which means they can trade with each other using those rules – 50% the rule of origin for automotive parts between Canada and Mexico. They can trade that way, and we do expect those shares to grow in the early years of USMCA. About 20% of auto parts from Mexico and 15% or so from Canada are not claiming NAFTA preference, so you are signing up for a stream of payments of the 2.5% tariff. Once you're paying the tariff, you could be making things anywhere, because we do offer that 2.5%. That’s the most favored nation tariff. When importing from any other WTO member where we don’t have a free trade agreement, you're paying the 2.5%. That could have the effect of moving supply chains out of North America. Getting rid of deemed originating is more impactful for moving supply chains than this very low to high percent. There is discussion, and it's been going on for a while in the negotiations of USMCA, about if the U.S. were to raise the MFN rate, which Mexico got a side letter to protect them, there would be consequences, and our trading partners can respond to that. But the U.S. so far hasn't made the official moves to raise the MFN rate, though they have done other actions, such as threatening tariffs on imports of vehicles and parts from Europe under the national security provisions. We could see higher tariff rates from other parts of the world, but once you’re paying 2.5%, you can make that stuff basically anywhere. USMCA might have higher content restrictions than NAFTA. However, the way we calculate the math is different, and the ability to roll up the total value of a compliant component does make it easier to meet this more stringent threshold. You can't just compare it simply as 62.5% under NAFTA to 75% under USMCA because a lot of those higher content requirements are washed away by making it easier to do the math to get to that requirement. NAFTA did not allow roll-up. Roll-up dictates that the parts content remains the same when you put it into another assembly. Under USMCA, if you have a part that is compliant, and you put it in a larger assembly, you can count 100% of that part toward the

FIA MAGAZINE | AUGUST 2020 30