Canada: Understanding The U.S. - Canada Trade Dispute: Where We Are And Where We're Headed

  • On May 31, 2018, President Donald Trump announced the imposition of 25% and 10% tariffs on U.S. imports of Canadian steel and aluminum products, respectively, effective June 1, 2018. Canada had previously been exempted from these tariffs, which the Trump administration had already been applying to most other countries worldwide.
  • In response, the Government of Canada announced on the same day that Canada intends to impose retaliatory tariffs against up to C$16.6 billion of imports of steel, aluminum and other products from the United States. These retaliatory tariffs are scheduled to take effect on July 1, 2018.
  • This note supplements our Tax Group's analysis of June 8 by looking more deeply into the background of the U.S. administration's actions, at the prospects for future tariffs and at the likely impact of a "trade war" on the M&A marketplace.

U.S. Tariffs on Steel and Aluminum

The administration's "national security" power

In April 2017, President Trump directed Commerce Secretary Wilbur Ross to investigate the impact of steel and aluminum imports on the national security of the United States, pursuant to the Section 232 of the Trade Expansion Act of 1962. Under this rarely used provision, should the Secretary of Commerce conclude that "[an] article is being imported into the United States in such quantities or under such circumstances as to threaten to impair the national security", the President has the discretion to unilaterally take any actions he deems necessary to "adjust the imports of such article so that such imports will not threaten to impair the national security". Congressional approval is not required in such a situation.

Findings of the section 232 investigation

In February 2018, Secretary Ross published his Section 232 investigation reports on steel and aluminum imports, which concluded that the quantities and circumstances of steel and aluminum imports into the United States are weakening the U.S. internal economy and are threatening to impair national security, and recommended the imposition of significant tariffs and/or quantitative quotas against steel and aluminum imports.

Imposition of the tariffs

Shortly thereafter in March 2018, President Trump announced the imposition of 25% tariffs on steel imports and 10% tariffs on aluminum imports from all countries, except Canada and Mexico. The exemption for Canada and Mexico was explicitly recognized as being tied to the ongoing renegotiation of the North American Free Trade Agreement (NAFTA). The initial exemption was set to expire on May 1, 2018, but was extended on the basis of progress in the NAFTA renegotiations. Because President Trump's May 31 announcement failed to provide a further extension of the exemption for Canada and Mexico, the steel and aluminum tariffs came into effect on June 1, 2018.

Justification under section 232

The national security justification for the U.S. tariff appears dubious. Section 232 is intended to address concerns that the United States should not be overly reliant on imports from countries that may be considered untrustworthy or potentially adversarial. However, for example, steel imports represent only about 20% of the steel products sold in the U.S. and those imports are primarily from longstanding allies to the United States like Canada, Europe, Mexico and Japan. Therefore, the Commerce Department's conclusion that steel imports are threatening to impair the national security of the United States seem difficult to justify.

Canada's Retaliatory Measures

Analysis of the U.S. strategy

The Government of Canada appears to view the U.S. actions under Section 232 primarily as an aggressive step by the U.S. administration to pressure Canada and other trading partners into making trade concessions. The timing of the President Trump's May 31 announcement vis-à-vis Canada appear to coincide with the stalling of progress in the ongoing NAFTA renegotiation.

Retaliatory tariffs

Shortly after the U.S. announcement, Canada declared its intention to impose retaliatory tariffs against U.S. exports into Canada. Canada's retaliatory measures are designed to be "dollar for dollar" – in other words, they will impact up to C$16.6 billion of U.S. exports into Canada (C$16.6 billion being the value of 2017 Canadian exports affected by the U.S. tariffs). As noted above, Canada's retaliatory tariffs are to take effect on July 1, 2018 and will remain in place until the United States eliminates its steel and aluminum tariffs against Canada.

Canada's retaliation strategy

Canada proposes to impose a 25% tariff on U.S.-origin steel products and a 10% tariff on U.S.-origin aluminum products and 70 other categories of industrial and consumer products (a list that may be further modified or expanded). It is clear that the proposed list of U.S. products subject to Canada's retaliatory tariffs is carefully designed to target specific U.S. states and regions that will have the greatest political impact, such as the home states of key congressional leaders (e.g., whiskies from Kentucky, the home state of Senate Majority Leader Mitch McConnell, and yogourt products from Wisconsin, the home state of House Speaker Paul Ryan) and swing states in the upcoming election this fall (e.g. orange juice from Florida).

U.S. origin products only

Canada's retaliatory tariffs will only apply to products originating from the United States, as determined in accordance with the Determination of Country of Origin for the Purposes of Marking Goods (NAFTA Countries) Regulations. This means that products that are merely in transit through the United States, or products that only go through minor processing in the United States that does not affect their origin (such as marking, tagging or packing) and which are onward shipped to Canada will not be subject to the retaliatory tariffs.

Pursuit of resolution via NAFTA and the WTO

Concurrently, Canada has requested consultations with the United States under Chapter 20 of NAFTA. Like a number of other countries, Canada has also requested consultation through the World Trade Organization over the legality of the U.S. tariffs on steel and aluminum.

Additional Section 232 Targets

On May 23, 2018, the U.S. Department of Commerce initiated another Section 232 investigation, this time into the impact of automobiles and auto parts imports on national security. Given the cross-border integration of the auto supply chain in North America, tariffs on automobiles and auto parts would cause substantial disruption to the North American auto industry. This appears to be a step towards further escalation by the United States in this "trade war", all in an effort to exert additional pressure on Canada in the ongoing NAFTA renegotiation. Additional Section 232 investigations and tariff against other categories of products cannot be ruled out, which would inevitably result in additional retaliatory measures by Canada and other affected countries.

M&A Considerations

The imposition of these tariffs on imports of steel and aluminum products and the proposed imposition by Canada of similar tariffs will undoubtedly have an impact on many businesses on both sides of the border. To close with a couple of general M&A-related thoughts:

  • Those contemplating acquisitions or divestitures of businesses in industries affected by the tariffs should consider the potential impact of U.S. tariffs on cash flow, working capital and ultimately on the purchase price. Reduced access to the U.S. market can certainly have a significant adverse impact on business valuations. Given the uncertainty around the duration of this "trade war", buyers may wish to consider building in flexibility to allow for appropriate adjustments to the purchase price and to provide for options to walk away from any proposed acquisition.

Other considerations may arise, depending on the circumstances of particular transactions. Parties should seek the specific advice of counsel to ensure adequate protection of their interests and appropriate risk allocation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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