Canada: Outsourcing For NAFTA Benefits: How Marking Rules Can Remove Duties

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on International Trade & Investment, June 2009

A recent decision by the Canadian International Trade Tribunal (CITT) demonstrates the complexity of international trade rules, as well as the resulting benefits to those companies who take extra care to work through them in detail. In this case, the importer of certain T-shirts who outsourced assembly to Mexico successfully demonstrated that the goods were eligible for "duty-free" importation into Canada under the North American Free Trade Agreement (NAFTA). However, the journey leading to the result was not entirely free of complications.

The recent CITT decision in A & G Inc. d.b.a. Alstyle Apparel v. President of the Canada Border Services Agency dealt with imports into Canada of certain T-shirts made exclusively of U.S. origin parts that were sewn together in Mexico. The importer and the Canada Border Services Agency (CBSA) were in agreement as to the proper tariff classification of the goods (the goods in issue were classified under tariff item No. 6109.10.00 of the schedule to the Customs Tariff) and also that the goods qualified for preferential tariff treatment under NAFTA. The issue concerned how much of a benefit under NAFTA was available to the goods at issue.

In particular, at the time the T-shirts were imported into Canada in March 2001, all customs duties had been eliminated on qualifying goods originating in the U.S.; however, customs duties imposed on qualifying goods originating in Mexico were still subject to the gradual elimination provisions under NAFTA. At the time the T-shirts were imported, they would be "duty free" if the "U.S." tariff rules applied, but would be subject to duties of 5% if the "Mexico" tariff rules applied.

In arriving at its decision, the CITT referred to: one international agreement (the North American Free Trade Agreement); no fewer than four statutes:

  • Customs Tariff
  • Customs Act
  • Official Languages Act
  • Interpretation Act

and no fewer than five regulations:

  • NAFTA Rules of Origin Regulations
  • Proof of Origin of Imported Goods Regulations
  • NAFTA Tariff Preference Regulations
  • Determination of Country of Origin for the Purposes of Marking Goods (NAFTA Countries) Regulations
  • CCFTA Verification of Origin Regulations .

Once the CITT worked through the various applicable statutes and regulations, the CITT concluded that the issue could be resolved by the country of origin marking rules: namely, the T-shirts would be subject to the "U.S." tariff or "Mexico" tariff depending on which "country of origin" applied to the goods.

The CITT first considered the rules in the Customs Tariff on when "preferential tariff treatment" may be claimed on imported goods and the two conditions that must be met. The first is the requirement that "proof of origin" be shown. This essentially requires that an exporter's certificate of origin be issued and available to the CBSA. The CITT noted the certificate requirement but did not confirm whether factually the certificate was duly prepared and in existence. The second condition for preferential tariff treatment to apply is a demonstration that the goods are in fact eligible for the preferential tariff treatment claimed (i.e., either the duty-free U.S. tariff or the 5% Mexico tariff).

In considering whether the U.S. tariff or Mexico tariff should apply to the T-shirts, the CITT zeroed in on the NAFTA Tariff Preference Regulations, which in turn required a detailed review of the Determination of Country of Origin for the Purposes of Marking Goods (NAFTA Countries) Regulations (the NAFTA Marking Regulations). The relevant rules comprised 10 separate sections, subsections and/or paragraphs which are drafted so that they must be considered in sequential order until a provision is found that is applicable to the goods at issue.

The CITT reviewed nine of the 10 rules before finding one that was applicable to the T-shirts at issue, namely the rule dealing with "simple assembly". In particular, section 7(b) of the NAFTA Marking Regulations indicates that if the production of goods is by "simple assembly" and the parts that merit equal consideration have the same country of origin, the country of origin of the parts applies to the goods. Four requirements must be satisfied in order for the goods to meet the definition of "simple assembly". The goods at issue met the first and second criterion which required there to be five or fewer parts, all of which were foreign. The third criterion, which was also met, was that the goods were assembled by sewing. Finally, the most complex requirement under definition of "simple assembly" is that the five or fewer components must be fit together "by bolting, gluing, soldering, sewing or any other means without more than minor processing".

The CITT noted that there were two possible interpretations of this criterion under the English text of the Regulation. One possible interpretation was that the fitting together of the pieces must take place by "sewing" or "any other means without more than minor processing". The other possible reading was that the assembly must take place by "sewing ... without more than minor processing" or by "any other means without minor processing".

Fortunately for the appellant, the French text of the NAFTA Marking Regulations resolved these ambiguities. The French wording and punctuation clarified that it is permissible for something else, in addition to sewing, to be done to the goods (e.g., the addition of a label) so long as it is "minor processing". Accordingly, the CITT was of the view that the proper interpretation was that the means of fitting together five or fewer parts by sewing constitutes a "simple assembly". The CITT then determined that the various T-shirt components meriting equal consideration had the same country of origin – the United States – and therefore the goods were considered U.S.-origin and subject to the U.S. preferential tariff, which enabled duty-free importation of the goods.

This decision highlights the benefits that may accrue to traders who take the extra time to understand rules of origin, complex as they may be, and who structure their operations to take advantage of the preferential tariffs. The decision should provide some comfort to companies, like the appellant in this case, that outsource to the extent that generally goods will not lose their entitlement to a preferential tariff based simply on the fact that their assembly has taken place in another territory so long as that assembly operation does not go beyond sewing (or bolting, gluing, soldering, or any other means, as the case may be) in addition to other "minor processing".

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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