Jean Monnet Center at NYU School of Law

An Evaluation of the Uses and Importance of Rules of Origin, and the Effectiveness of the Uruguay Round's Agreement on Rules of Origin in Harmonizing and Regulating Them

Joseph A. LaNasa III ("Jody")

©Copyright: Joseph A. LaNasa III, 1995.

Table of Contents

I. Introduction: The Importance of Rules of Origin
II. The Use of Rules of Origin as Barriers to Trade
III. Rules of Origin as a Factor of Production
IV. Methods of Determining Origin

A. Substantial Transformation
B. Value-Added Percentage Test
C. Specified Processes
D. Change in Tariff Classification

V. Efforts for Global Harmonization of Rules of Origin

A. Attempts Prior to the Uruguay Round
B. The Uruguay Round Agreement on Rules of Origin

VI. The Origin Agreement
VII. Conclusion

I. Introduction: The Importance of Rules of Origin

Rules of origin are the criteria used to determine the nationality of a product. Rules of origin were designed as an uncontroversial, neutral device essential to implementing discriminatory trade policies, compiling economic statistics, and marking a good. Once the origin of a good is known, the importing country can apply any country-specific or trade area-specific trade preferences or restrictions to the imported good (such as dutyfree entry for goods originating in a free trade area, quantitative restrictions on goods originating in a country subject to a quota, or anti-dumping duties on goods from the targeted company that originate in the targeted country), account for the good in its compilation of economic statistics on trade flows, and ensure that the good is conspicuously marked with its country of origin. Rules of origin remained an uncontroversial, neutral device as long as the parts of a product were manufactured and assembled primarily in one country, and as long as other mechanisms for implementing protectionism existed.

Because rules of origin are an indispensable means of implementing discriminatory trade regimes, their importance has grown significantly as countries increasingly have treated similar imported goods differently according to where the product was made. [1] As the degree of differentiation among similar goods from different countries or trading groups increases, rules of origin become more important and more controversial, because the benefit of being determined to be from a certain country or trading group vis-B-vis others increases. [2]

The increased disparate treatment of similar goods, the growing number of restrictions placed on the use of traditional tariff and non-tariff barriers to trade by the General Agreement on Tariffs and Trade ("GATT"), the lack of regulation of rules of origin until recently by the GATT, the technical obscurity in which rules of origin operated, and the globalization of means of production provided countries with the opportunity and incentive to use their rules of origin to implement trade policies in an obscure manner.

The rise of multinational corporations and the production of goods in multiple stages using parts produced in different places around the world provided an opportunity to use rules of origin as an effective means of protection. In a world where goods are produced from parts from around the world, there is no single, correct definition of origin. Instead, the origin of a product depends on the formulation and application of the applicable rules of origin. In this world, rules of origin can serve as an extremely effective means of protectionism in at least two ways. First, overly restrictive definitions or applications of preferential rules of origin may deny trade preferences to products that last underwent substantial processing in a favored country or trading area by holding that the product did not originate in the favored country. Second, overly liberal definitions and applications of non-preferential rules of origin will extend country-specific trade restrictive measures to products otherwise exempt from them by holding that the product, even though it last underwent substantial processing in a third country, originated in the disfavored country.

Because most people had the misconception (a proper conception as long as imported goods where produced in a single country with parts and materials from that country) that the formulation and application of rules of origin result from a technical, objective process, few people paid attention to, much less scrutinized, the process of defining and applying rules of origin. This lack of transparency was heightened by the complex, technical nature of rules of origin, which would have made it difficult to realize that they were being used for restrictive purposes. Furthermore, while the GATT increasingly restricted the ability of countries to use tariffs or traditional non-tariff barriers to protect domestic industry from foreign competition, it did not regulate rules of origin. Therefore, the use of rules of origin to insure trade restrictive effects provided a means for countries to satisfy pressure from domestic industry for protection from foreign competition. By taking advantage of the fact that formulations of the rules and determinations of origin are not objective, technical exercises but rather policy-influenced decisions made in a non-transparent manner, governments were able to protect domestic industries in a hidden, effective manner.

As a result of the growing pressure to find new barriers to trade, the lack of global regulation of rules of origin, and the effectiveness of rules of origin as a protective device, governments increasingly turned to rules of origin as a mechanism for protectionism. [3]

Part II of this article explores how countries use rules of origin in a results-oriented manner as a trade policy tool. Part III explains why profit-maximizing firms should treat rules of origin as a factor of production, and why they need clear, precise rules that result in consistent, transparent determinations of origin. Part IV of this article evaluates the different methods for determining the origin of a product. Part V reviews the history of efforts to harmonize the rules of origin on a global basis. Part VI examines the Agreement on Rules of Origin reached in the Uruguay Round (the "Origin Agreement"), [4] and analyzes its effectiveness in making origin determinations more transparent, less controversial, and more certain. Part VII concludes that while progress towards harmonization of the rules has been made, rules of origin will continue to be important and controversial as long as countries continue to treat similar imported goods differently.

II. The Use of Rules of Origin as Barriers to Trade

Rules of origin are divided into two categories: preferential and non-preferential rules of origin. Preferential rules of origin are used to determine whether certain products originate in a preference-receiving country or trading area and hence qualify for the trade preference. Non-preferential rules of origin are used for all other purposes, including enforcement of product and country specific trade restrictions that increase the cost of entry (i.e., antidumping duties) or restrict or prevent market entry (i.e., quotas). [5] Both types of rules of origin can be used as a barrier to trade.

By determining whether a product originates in a preference-receiving country or trading area and thereby enters the importing country on better terms than products from the rest of the world, preferential rules of origin allow governments to discriminate between products from different countries because instead of a global trading environment ruled by GATT's principle of non-discrimination and its most favored nation clause, countries have created a growing proliferation of trading agreements that give preferential treatment to developing countries and regional trading partners. [6] By varying the severity of the required transformation and by allowing different degrees of cumulation on a regional, donor, or global basis, countries use the rules of origin to control the degree of preference. [7] If the preferential rules of origin are formulated so that they require a greater transformation of the product than the rules of origin otherwise would require, the rules of origin may be serving as a discriminatory policy device that restricts trade.

The rapid, recent spread of reciprocal preferential trading agreements [8] that, inter alia, liberalize trade through the creation of regional free trade areas has focused increasing attention on rules of origin and their importance. While reciprocal, trade liberalizing preferential agreements in theory should result in net trade creation, their use of more restrictive rules of origin than the non-preferential rules, though nominally designed to prevent trade deflection, may result in trade and investment diversion.

Trade deflection occurs when companies place a minimal processing or assembly plant in a preference-receiving country to take advantage of those trade preferences. The preferential rules of origin attempt to prevent trade deflection by establishing criteria that ensure an adequate degree of transformation in a preference-receiving country to justify allowing a good to benefit from the preference. However, the rules of origin in reciprocal preferential trading agreements often are more restrictive than necessary to ensure substantial transformation. When the rules of origin are more restrictive than necessary to prevent trade deflection, they give producers an incentive to increase the amount of intermediate and final good manufacturing, processing and assembly done within the preferential area at the expense of facilities in other countries that would otherwise have a comparative advantage. This distortion of the sourcing and purchasing decisions causes an inefficient allocation of global resources. [9]

The effectiveness of restrictive rules of origin in diverting trade and investment will depend on the difficulty of complying with the rule, the size of the market, the degree of technical skill needed, the level of education of the work force, and the "penalty" for failing to comply with the preferential agreement. Multinational corporations will have greater incentive to source manufacturing and assembly plants within an area if the "penalty" for not complying with the preferential rule of origin is substantial, such as the loss of substantial tariff preferences or the loss of market access to a large market, rather than if the penalty is minimal, such as a small tariff on goods sold to a small market. Alternatively, if the preference is not that large or if the goods are destined for a number of countries, the firm may just ignore the preferential agreement and its intricate rules of origin.

These overly restrictive preferential rules of origin are not designed to protect final good producers, as traditional barriers to trade are. Instead, they are designed to increase the amount of investment in production and assembly of intermediate goods and to protect and enhance the position of existing intermediate producers. [10] This protection of intermediate producers results in inefficient trade diversion, and is the focus of non-member resentment of the preferential trading agreements. [11] Furthermore, over time, the domestic intermediate producers may be replaced, or crowded out of the market, by foreign producers who relocate their intermediate production facilities to the protected area.

However, rules of origin can also serve as a traditional barrier to trade, i.e., to protect domestic producers of final goods when the rules of origin are so administratively or technically difficult to comply that they serve as a non-tariff barrier to trade. If the penalty for non-compliance is severe enough, they will nullify the trade preference, because no firm will seek to take advantage of it. However, if one member's market is much larger than the other members, firms have an incentive to source factories in that country where most of the final goods are destined to be sold, so as to avoid having to comply with the origin rules. Because rules of origin are only applied to imported goods, i.e., goods crossing a national border, if the good is produced and sold domestically, no origin determination is necessary. Of course, its imported parts will have to comply with non-preferential trade law, including applicable tariffs and quotas.

III. Rules of Origin as a Factor of Production

Because rules of origin are an essential part of applying country-specific or trading group-specific trade preferences or restrictions, rules of origin have a significant impact on the strategic planning of profit-maximizing firms. For this reason, profit-maximizing firms should analyze the different rules of origin, quantify their cost, and treat them as a factor of production in determining where to source their investments, purchase their raw materials, produce or purchase intermediate materials, and assemble their final products.

Given raw or intermediate materials of equal quality, a profit-maximizing firm will purchase the cheapest one, regardless of where it is found. Because trade restrictions and preferences impact the cost of goods and may even restrict the entry of a material or good into a country, a firm should determine the origin of the raw or intermediate part it is considering using and its impact on the origin of the final good to see whether any trade restrictions or preferences apply. If a good from a certain country or trading group is subject to a quota or a measure having an effect equivalent to a quota, a firm will be less likely to use that good because its use may constrain the firm's production capabilities for its final product, because once the good's import limit has been reached, the firm is barred from importing any more of that good. If the good is subject to a tariff or a measure having an equivalent effect, then the firm should include the tariff in its cost calculations for that good in determining where to buy or produce the material.

A profit-maximizing firm should consider the origin of the final good in each destination market before determining where to source its manufacturing and assembly plants. By locating the plant in a country where the finished product receives the most beneficial treatment in the country or countries where the product will be sold, a firm could minimize the trade restrictions and maximize the trade preferences placed on that good.

Trade preferences and restrictions are two of many factors that must be considered in analyzing the relative and absolute costs of production. While they are not the sole criteria used to determine where to source manufacturing and assembly plants and where to buy raw materials or intermediate parts, their importance is often overlooked. [12] For example, if a firm produces a good which enjoys large production economies of scale, low transportation costs, and is sold in a number of countries, that firm may wish to produce all of that product in a factory located in the country that has the lowest total costs of production, including the cost of entry into the final markets. In other words, a firm should consider the cost of entry of the product into a market along with the cost of capital, the cost of labor, the skill level of labor, and transportation costs before determining where to source manufacturing and assembly plants and before determining where to buy raw materials or intermediate goods. This type of analysis should be conducted by all firms that produce products for more than one country, regardless of whether the product will be used by another producer or whether the product will be sold to the more traditional consumer.

Given the importance of origin determinations to rational, profit-maximizing firms, firms should determine the origin of their final goods in advance, so that they can account for it as a factor of production in their strategic plans. However, the fialure to harmonize rules of origin on a global or even national level has impeded efforts to make such determinations, as countries often apply a number of different rules of origin applied by countries, often resulting in inconsistent determinations of origin, which sometimes appear to have been manipulated to achieve trade-restrictive results. The creation of clearly stated, globally-harmonized rules of origin that are applied consistently would provide significant benefits to profit-maximizing firms. The goal of any harmonization project should be to articulate rules of origin that distinguish between substantial and insubstantial transformation in a consistent and neutral fashion, and to have these rules applied consistently, so that origin determinations result in similar results, regardless of where, when, and why they occur. Before recent harmonization attempts may be evaluated, the types and different methods of determining origin must be explored.

IV. Methods of Determining Origin

When a product is wholly obtained and produced in a single country, it is relatively easy to determine its origin. [13] Difficulties arise in determining the origin of a product that is manufactured in, assembled in, or uses materials originating in more than one country.

At least four different methods or criteria exist for determining the origin of goods that are manufactured in, assembled in, or use materials originating in more than one country:

1. Using the concept of substantial transformation as a rule;

2. Using an ad valorem percentage test;

3. Listing specific manufacturing or processing operations which confer or do not confer origin upon the goods; and

4. Requiring a specified change in tariff classification.

Whichever method is employed to determine origin, each seeks to prevent simple assembly and packaging operations from conferring origin. This section of the article will evaluate the different methods according to their effectiveness in determining the origin of a goal and in preventing circumvention, their clarity, their certainty, their transparency and the predictability or consistency of origin of determinations which use that method.

A. Substantial Transformation

The traditional substantial transformation rule states that a good originates in the last country where it emerged from a given process with a "distinctive name, character or use." [14] The substantial transformation of a good requires more than just a change in the article; it requires an article be transformed into a "new and different article" "having a distinctive name, character or use." [15]

The traditional substantial transformation rule captures the heart of the meaning of the rules of origin in a simple, concise way. For a product to be from a particular state, it must be substantially transformed there. To prevent a product from having multiple countries of origin, the good is a product of the country where it last underwent substantial transformation. The standard's flexibility allows it to evolve to meet technological change; however, this flexibility can result in inconsistent origin determinations that undermine the certainty required for strategic planning by businesses.

Moreover, the standard's flexibility provides an opportunity for it to be "captured" by lobbying groups, i.e., for the standard to be used in a results-oriented manner designed to accommodate political pressure for more trade restrictive effects. For example, the rule can easily be converted into a search for the most significant processing, instead of the last substantial transformation. This type of search requires the exporter, importer, or producer to furnish a great deal of factual information to prove substantial processing. This fact-intensive, time-consuming inquiry raises the cost of determining origin, makes the rule even more restrictive and complex than it otherwise would be, and contradicts the spirit and purpose of the last substantial transformation rule.

For example, in 1984, the United States Custom Service adopted a two-part test for determining the origin of textile goods that result from processes or materials from more than one country. [16] This "revised" substantial transformation test was more restrictive than the traditional substantial transformation test because it required the creation of a new and different article and substantial manufacturing or processing operations. [17] The revised test nominally was changed to prevent companies from circumventing textile quotas by passing goods through an intermediate country to confer that country's origin on the good.

The substantial transformation rule provides the custom authorities and the courts with a great deal of flexibility to adapt the rule to particular circumstances to avoid circumvention. As the amount of restrictions or duties on imports increases for unfavorable origin determinations, more companies will try to manipulate the rules of origin to avoid unfavorable determinations. This often forces the courts to stretch the common law developed around substantial transformation to prevent circumvention and ensure that the standard's basic purpose is met. In other words, as the rules on substantial transformation become more precise and defined, it becomes easier to circumvent the purpose of the law while formally complying with its language. The flexibility of the substantial transformation standard provides countries with the ability to look beyond the form of the transaction to see if a substantial transformation actually occurred.

However, the ambiguity of the standard and its flexible decision-making can lead to unpredictable, seemingly arbitrary results, especially when substantial transformation rule is applied differently for different purposes. [18] The United States has attempted to deal with this lack of certainty by compiling lists of criteria. [19] However, instead of having the abstract concept of substantial transformation become more definite through concrete application to factual situations, [20] the selective, inconsistent use of the criteria has led to more uncertainty and confusion. [21]

Some of the seemingly inconsistent and arbitrary determinations result from the fact that the rules are applied for different purposes. Courts and agencies may expend more effort on determining the true origin of a good for trade preferential or restrictive purposes than for marking purposes, and therefore the inconsistency may not be a sign of results-oriented policy-making. In other words, the seemingly fragmented and inconsistent application of the substantial transformation standard may be proof that the substantial transformation is working effectively, in that its abstractness gives it the flexibility to specifically address the facts of each situation and prevent circumvention. However, to some commentators, by varying the degree of transformation required according to how the origin determination will be used, the "only consistency [in defining substantial transformation in the United States] is a policy that results in either higher duties or in fewer imports." [22]

While the flexibility of the process leaves it open to political pressure and capture by lobbying groups who want overly restrictive applications of the standard for protectionist purposes, this problem exists with every method of determining origin, just at a different stage in the determination process. With more defined methods of determining origin, the capture and manipulation occurs when the definitions are being developed or by having the definitions rewritten or re-interpreted. Moreover, the rules are defined for these other methods in the definitional stage where there is no adversarial relationship, no neutral decision-maker, no representation of the major viewpoints, and no factual situation to which the principle can be applied, unlike many of the applications of the substantial transformation standard. Therefore, a greater danger of capture and protectionism may exist with the more defined methods because of the lack of court oversight and the lack of the adversarial representation.

In summary, the substantial transformation standard has many advantages, including its flexibility, evolution over time, and development through application to specific facts in an adversarial situation where interested parties are represented. However, these advantages are also the root of its disadvantages: its inconsistent applications, its discretionary nature, and the costs of making an origin determination under it. The adoption or rejection of substantial transformation as a method of determining origin depends on which principle one values more: flexibility or certainty. While profit-maximizing firms need more objective, predictable and easier to use rules, the substantial transformation standard should be used as the motivating principle behind the development and continued refinement of more precise, defined rules of origin, because it captures the purpose of origin determinations in a simple, concise manner.

B. Value-Added Percentage Test

The value-added test defines the degree of transformation required to confer origin on the good in terms of a minimum percentage of value that must come from the originating country or of maximum amount of value that can come from the use of imported parts and materials. [23] If the floor percentage is not reached or the ceiling percentage exceeded, the last production process will not confer origin. If the determination is for non-preferential purposes, then origin will be conferred on a prior country; if it is for preferential purposes, then no further origin determination is necessary unless the prior county is also a beneficiary country under a preferential trading agreement with the importing county.

While the value-added method is often praised for its simplicity and precision, [24] in practice it is very far from that because it generates substantial compliance costs and uncertainty for companies. [25] The value-added test is a very unsatisfactory method of determining origin.

The value-added test generates substantial compliance costs for companies. It can be very costly and difficult to comply with its administrative requirements, especially if the rules require tracing the value of specific parts and materials. Firms often will find it cheaper not to comply with the value-added test, forgoing the trade preferences and paying the most-favored-nation tariff, when the product results from complex manufacturing operations or when the product does not otherwise face high tariff or non-tariff barriers. [26] To comply with a value-added rule requiring tracing, a manufacturer of a complex product would need a highly sophisticated inventory and accounting system to adequately ensure that particular goods contain specific local components at specific values.

The value-added test also generates substantial uncertainty for companies. Because the test ignores exchange rate risk and fluctuations in the price of raw materials, the status of goods can change daily as the currency values fluctuate or as the price of raw materials fluctuates, unless the firm is able to obtain a binding advance ruling from the country's customs authorities. [27] Additionally, the origin of identical goods may vary with each importing country, depending on the exchange rate relationship between the importing country's currency and that of the processing country. Furthermore, because the value-added test is a bright line test, it often results in seemingly arbitrary results for borderline cases. For example, if the rules require 50% local value-added to confer origin, then a good with 49% local value added will be denied origin while a good with 50% local value added will considered to originate there. When a firm seeks a certain origin, it may seek to manipulate the prices of the good and its imports to ensure the desired origin determination. This threat of transfer pricing is especially prevalent with transactions among related parties. For example, related parties could underprice the imported materials so that the final good has enough local value-added to qualify for local origin. To limit or prevent this manipulation of "value-added", the rules of origin could force the related parties to show that the price is similar to prices reached in an arm's-length transaction, whether by showing that the price is similar to the price of identical materials or goods sold to third parties, as long as third parties have purchased a substantial number of those materials or goods, or by comparing it to the price of similar materials or goods sold in arm's-length transactions, or it could force them to use a "net cost" method of determining value-added. [28] For example, in the NAFTA, the producer or exporter must use the "net cost" method when there is no transaction value (price) for the good or when the good is sold to a related party and related parties have purchased over 85% of the producers' identical or similar goods during the preceding six months. [29]

Moreover, the value added test leads to inconsistent results for similar products, because countries calculate the amount of value-added in different manners. [30] For example, the value-added test may result in inconsistent determinations of origin of identical goods in different countries because different countries include different amounts of the transportation costs in the "sales prices" for the good, thereby creating different sales prices for the same good. [31] The later the article is valued in the transport stage, the harder it becomes for the article to meet the local value-added content requirements, because the transport costs increase the value of the denominator, unless the delivery costs are also added to the numerator as originating costs. Further, even if countries valued all parts of the good at the same stage in the transport cycle, they would still have different origin determinations because countries include different costs in its local value-added calculations. [32]

The value-added test penalizes low cost production operations, though they may be more efficient than high cost facilities. The value-added test penalizes labor-intensive facilities in countries with cheap labor costs, capital-intensive facilities in countries with cheap capital costs, and resource-intensive facilities in countries with cheap resource costs. Because there is a greater difference in the cost of labor than the cost of capital since capital is more mobile than labor or raw materials, the value-added test discriminates against lesser developed countries whose primary comparative advantage is cheap labor and cheap materials. [33]

As with any defined test, a value-added test is subject to industry capture during its formulation stage. For example, in the North American Free Trade Agreement, American automobile manufacturers pressured the negotiators into accepting overly restrictive special rules of origin for automobiles, [34] ones that had a higher regional value content requirement for automobiles than for other goods under the North American Free Trade Agreement. [35] Furthermore, to purportedly prevent roll-up, [36] NAFTA requires that the producer trace the value of imported automotive parts throughout the production chain [37] to improve the accuracy of the content calculation, thereby imposing substantial additional compliance costs and administrative burdens on the manufacturer. The combination of higher regional value content requirement with the tracing provisions forces automotive companies to manufacture the drive trains and engines of the vehicles within the free trade area if they want the good to qualify for preferential treatment, or, if they want to avoid the rules of origin, to source their assembly plant in the final market country, i.e., the United States. [38]

In summary, due to differences in calculation methods, the fluctuations in values, and the compliance costs, the value-added test is not a satisfactory method of determining origin.

C. Specified Processes

The specified process tests of origin, also referred to as technical tests, prescribe certain production or sourcing processes that may (positive test) or may not (negative test) confer originating status. [39]

The specified process test serves as a useful supplemental test because it is easily tailored to meet a specific situation in a clear, precise manner. However, it is not a satisfactory primary test of origin because it would be extremely difficult, if not impossible, to define a process test for the enormous array of products made, and to continually update these rules for new products and technological advances in production. Second, such a process of defining origin would be highly susceptible to capture by industry lobbying groups, because the drafters and administrators of the rule would have to rely upon industry for information, and, because the test would be in technical terms, its content would be hidden from public view. For example, Commission Regulation 288/89, on determining the origin of integrated circuits, stated that origin is conferred on a good whenever it undergoes diffusion. However, diffusion is always followed by assembly and testing, processes that are more labor-intensive and that may add more value than diffusion. [40] This product-specific technical rule was adopted because European Community producers of integrated circuits performed the diffusion process in the European Communities and then had the testing and assembly done in third countries while Japanese producers of integrated circuits had them tested and assembled in the European Communities. [41] Therefore, this regulation conferred EC origin on goods produced by EC manufacturers while denying EC origin on goods produced by Japanese manufacturers, thereby allowing the integrated circuits produced by the EC companies to trade on better terms than those produced by the Japanese. [42]

Third, it is a rigid test whose form could be met while subverting the underlying concept of requiring a substantial transformation to confer origin. Meeting this problem with anti-circumvention provisions would re-introduce the fact-intensive inquiries and their corresponding uncertainty that the technical and other defined tests seek to avoid.

Finally, negative technical tests leave large gray area, in that they only delineate which processes do not confer origin. For example, Commission Regulation 2071/89, on determining the origin of photocopiers, stated that the incorporation of an optical system into a photocopying apparatus will not confer origin, but did not explain which operations would confer origin. [43] This regulation was designed specifically to deny United States origin to copiers assembled in the United States by Ricoh, a Japanese corporation. [44] These copiers contained imported Japanese optical systems, and therefore were viewed as "Japanese" copiers by the origin test. Because anti-dumping duties had been imposed on Ricoh copiers from Japan, these copiers, which were assembled in the United States, were now subject to these duties.

D. Change in Tariff Classification

The change in tariff classification method determines the origin of a good by specifying the change in tariff classification of the Harmonized System of Tariff Nomenclature ("Harmonized System") [45] required to confer origin on a good. [46] Because the Harmonized System has been adopted by countries representing 90% of the world's trade, it provides a uniform, hierarchical nomenclature to be used in defining origin determinations for all products [47] in international trade.

The Harmonized System's systematic, hierarchical framework and its nearly universal acceptance among trading nations permit the drafters of rules of origin tremendous flexibility to define classification changes in a precise manner that sustains exceptions and special rules without sacrificing objectivity, certainty, or identity. [48]

The Harmonized System is divided into twenty-one Sections, each representing a broad industrial grouping; ninety-six Chapters, each representing a more narrow industrial sector; and one thousand two hundred and forty-one headings, each representing a narrow industrial section. [49]

The headings in a chapter generally are ordered by the degree of processing. The farther into the chapter the heading is, the more processing that good has undertaken. [50] Therefore, unless the rules of origin specify otherwise, any change in the level of classification of the product at the heading level should be sufficient to confer origin on that product in the country where that change last occurred; hence, this method of determining origin is often called the "change in tarrif heading method." [51] The Harmonized System's hierarchical framework, its division by industry, and its systematic arrangement of headings by increasing degrees of technical sophistication and economic effort provide an easy to use and easy to adapt underlying structure for origin determinations.

While the Harmonized System reflects the most sophisticated and refined tariff classification system, it is just that -- it's a system primarily designed for the dual purposes of commodity classification and compilation of statistics. [52] Because it was not designed to be used for origin determinations, changes in classification are not always an appropriate or effective test for determining origin. Therefore, an origin scheme based on change in tariff classification must be supplemented by a list of exceptions that describe when a sufficient transformation has occurred despite the lack of a change in tariff classification, [53] when a change in classification is not sufficient, [54] and which processes are not sufficient to confer origin even though they lead to a change in tariff classification. [55] These supplemental tests, which rely upon process and value-added tests as supplemental tests for origin, reintroduce the problems associated with those systems into the change in tariff classification system, albeit on a lesser scale than if these tests were the primary tests. As with any process system, both the required changes and the exceptions lists must be updated to reflect new products and technological advances.

The change in tariff classification method of determining origin is conceptually simple and easy to apply, once the product is classified. [56] Because the Harmonized System is already used to classify 90% of the goods in international trade, custom authorities, exporters, importers, and manufacturers are comfortable and familiar with it. However, the classification of the product can give rise to problems, because products are not always classified in a uniform manner, despite the substantial efforts of the Harmonized System Committee to ensure that they are. [57] While it may appear that the change in tariff classification test which uses the Harmonized System as its underlying nomenclature will result in uniform determinations of origin because all of the countries are using an internationally harmonized nomenclature, this may not be the case because each country is free to classify the good as it sees fit, unless a system of binding dispute resolution open to both individual and member country complainants is developed.

V. Efforts for Global Harmonization of Rules of Origin

A. Attempts Prior to the Uruguay Round

Beginning in the early twentieth century, rules of origin developed gradually with the development of differentiated tariffs and other trade measures. [58] Prior to the Uruguay Round of Multinational Trade Negotiations (the "Uruguay Round"), the General Agreement on Tariff and Trade (GATT) did not attempt to harmonize rules of origin; instead, it left each contracting party free to determine their own rules of origin. [59]

In 1953, the International Chamber of Commerce (the "ICC") made the first attempt to harmonize rules of origin when it submitted a resolution to the Contracting Parties to GATT recommending the adoption of a uniform definition for determining the nationality of manufactured goods. Under their proposal, a product "resulting exclusively from" labor and material in one country would originate in that country, and a product resulting from materials and labor of two or more countries would originate in the country where the product last underwent a substantial transformation. [60] A substantial transformation was defined as processing that confers a new individuality on the goods, and these processes were to be listed by each Contracting Party. [61] By establishing the abstract principle of substantial transformation as the guiding definition, the ICC believed the Contracting Parties would create similar lists of processing resulting in a substantial transformation. The ICC proposal was not adopted by GATT, because some countries [62] wanted a standard international definition of origin and uniform rules for determining the origin of imported goods, while another group [63] was skeptical of any kind of international definition of origin because they considered origin to be "`inescapably bound up with national economic policies, which are unavoidably different in different countries.'" [64] This split in the countries over the ICC proposal in the 1950s foreshadowed a split that exists today between those countries which view rules of origins as an instrument of commercial policy and those which view them as technical, objective, and neutral instruments. [65]

In the 1970's another effort was made a global harmonization of the rules of origin. Annex D.1 of the Kyoto Convention [66] represented a multilateral attempt to move towards the harmonization of all rules of origin, both preferential and non-preferential, by adopting guidelines based on the principles of wholly obtained goods and substantial transformation that countries would use in drafting their rules of origin. The Kyoto Convention's rule of origin for goods wholly obtained in the originating country has been adopted repeatedly by other trade agreements. When two or more countries are involved in the production of a product, the Kyoto Convention states that the product originates in the country in which the last substantial transformation took place. Because the Kyoto Convention recognized that substantial transformation is a rather vague concept, it provided a list of methods to be used in defining substantial transformation more precisely. [67] Under the Kyoto Convention, as under the ICC proposal, member countries retained a great deal of discretion to fashion the rules of origin as they deemed fit.

B. The Uruguay Round Agreement on Rules of Origin

The Origin Agreement represents an attempt to regulate and harmonize the rules of origin used by the signatories. The European Communities' use of the rules of origin to implement politically motivated, trade restrictive and trade distortive formulations and interpretations of the rules of origin led to the inclusion of rules of origin as a topic for negotiation in the Uruguay Round. [68] In recent years, the European Community has engaged in result-oriented rule making where, under pressure from European industrial lobbies, the Commission or the Origin Committee would change the rules of origin so that goods produced by foreign companies that initially complied with the technical requirements of the applicable origin regulations no longer complied with them and therefore were subject to higher tariff rates, restrictive quotas, or anti-dumping duties. [69] The rules of origin would be changed by re-interpreting the applicable rules in a stricter fashion, by re-writing them with carefully tailored, stricter rules, or by adopting special product-specific rules of origin. [70]

VI. The Origin Agreement

The Origin Agreement seeks to harmonize all the non-preferential rules of origin used by signatory countries into a single set of international rules. Under the Origin Agreement, each country is free to adopt its own preferential rules of origin, or to adopt different preferential rules of origin for its different preferential agreements. [71]

The Origin Agreement anticipates a two stage harmonization process. First, the Origin Agreement anticipates a three-year transitional period, [72] during which time the harmonized rules will be drafted and adopted. The proposed harmonized rules will be drafted by the Technical Committee on Rules of Origin, with the Committee on Rules of Origin considering its results "with a view to endorsing such interpretations and opinions." [73] The Origin Agreement does not specify whether consensus decisions, majority voting, or supermajority voting will apply. [74] However, by drafting the rules in a multilateral context where all countries are represented and where the adopted rules will be used for all non-preferential purposes, the ability of any one country to draft the rules in politically motivated ways will be limited. For example, if the United States sought to protect its domestic car industry by having the harmonized rule of origin for automobiles be unduly restrictive, those same American companies would be injured when they sought to export their automobiles to other countries. Once the harmonization work program is completed, a GATT Ministerial conference will establish the results of the harmonization program as an Annex to the Origin Agreement, along with a time frame for its entry into force. [75]

Three criteria will be used to define origin under the harmonized rules. First, the Technical Committee will develop a detailed harmonized definition for determining when goods are wholly obtained in one country. [76] Second, the Technical Committee will develop a harmonized list of minimal operations or processes that do not by themselves confer origin to a good. [77] Finally and most importantly, the Technical Committee will define when the last substantial transformation of a good produced in more than one country occurrs, primarily through use of the change in tariff classification method at the heading or sub-heading level, using the Harmonized System as the underlying nomenclature, and, when supplemental tests are necessary, through the use of the value added and specified processing methods of determining origin. [78] The Origin Agreement states that origin will be conferred where the last substantial transformation occurred, not where the most significant occurred. This rule increases certainty in application and simplifies the determination of origin because the custom authorities can disregard previous operations.

Both during and after the transitional period, the member countries are forbidden from using negative rules, unless they are used to clarify a positive standard or when a positive determination is not necessary. [79] This provision will make the rules of origin more specific and clear, because negative provisions only state what will not constitute a substantial transformation, not what will constitute a substantial transformation. This provision is aimed at the criticized European Communities practice of issuing product-specific origin regulations that use negative rules, such as European Communities Regulation 2071/89, which was allegedly changed to confer Japanese origin on photocopiers produced by Ricoh (a Japanese company) in the United States in order to apply anti-dumping duties imposed on Japanese photocopiers on these United States assembled copiers.

The Origin Agreement provides for an advance publication and ruling procedure to be implemented in each signatory country, starting immediately, for all origin determinations. [80] Signatory countries must publish the rules of origin and any applications of the rules. [81] Any changes in the rules can not be applied retroactively. [82] Upon the request of any interested person, [83] the member country must issue and publish a binding assessment of origin within 150 days of a request containing all the necessary elements. [84] This assessment must clearly and precisely state what requirements must be met to confer origin. [85] Any confidential information submitted by the parties shall remain strictly confidential, unless the person or government providing it specifically permits its disclosure or unless judicial proceedings require disclosure. [86] The assessment request can be made in advance of trading in the good and once made, will be valid for three years in all comparable situations. [87] This advance ruling procedure will allow firms to rationally plan its sourcing and production processes with knowledge of the final good's origin and corresponding treatment. [88]

Additionally, because the assessments will be published, interested parties will be able to make more cogent arguments for favorable rulings, using these prior rulings as precedents, because these prior rulings will be binding on the custom authorities for three years in all "comparable" situations. This process, which improves on the American system of inconsistent review of determinations of origin, will create a more fact-specific, common law-like context for origin determinations that will lead to fairer, more objective determinations as the rules are explained through application to specific factual situations. Because the determinations are binding in comparable situations, are published, and are subject to review, there will be implicit pressure on the custom authorities to explain their reasoning, thereby increasing the transparency and consistency of the process.

Starting immediately, any administrative action taken with regard to the determination of origin for either preferential and non-preferential purposes is reviewable promptly by an independent authority. [89] This independent review may be made by a judicial, administrative, or arbitral tribunal which has the power to modify or reverse the determination. [90] The prompt review by an independent body will lead to a system closer to one based on the rule of law. It will serve to increase the transparency, neutrality, consistency, and legitimacy of origin determinations, because an independent body will be deciding the correctness of its application after hearing presentations from both sides.

Despite numerous advances over existing systems of origin determination and harmonization of rules and decision-making processes, the Origin Agreement will not lead to harmonized determinations. During the transition period, each member country will apply its own non-preferential rules, subject to limitation that "notwithstanding the measure or instrument of commercial policy to which they are linked, the rules of origin are not to be used as instruments to pursue trade objectives directly or indirectly." [91] This provision implies that the member countries should not use the rules of origin as commercial policy instruments, but rather as a technical, definitional device. The question arises as to whether applying different rules for different purposes means that the country is using the rules of origin as a trade policy instrument or whether different commercial policy tools need different rules of origin to effectively implement them. If the latter is true, the exclusion of preferential rules of origin from the harmonization implies a recognition by the drafters that some commercial policy instruments, i.e., preferential trade agreements, may require special rules of origin to control the degree of preference and prevent trade deflection. But the question arises as to why some instruments require special rules of origin while the other instruments can apply the same rule. If voluntary restraint agreements are also exempted from the harmonization program, then the key differentiating factor between those tools which must use the harmonized rules and those which are free to design their own rules of origin may be that in voluntary agreements, such as preferential trading agreements and voluntary restraint agreements, the parties are free to design their own rules of origin, but whenever the trade restriction is being applied unilaterally, the country should be forced to use the harmonized rules of origin so that the rules of origin are not being used as a hidden policy tool. After the transitional period ends, each member country is free to disagree with how it interprets the harmonized non-preferential rules. Both during and after the transitional period, the member countries will be applying their own preferential rules.

After the transitional period ends, the same non-preferential rules of origin will be applied for all non-preferential purposes by the signatory countries. Because these harmonized rules will be defined primarily in terms of change in tariff classification and secondarily in terms of specified value-added requirements and specified technical processes, they will replace the use of the vague, discretionary concepts such as substantial transformation or last substantial process with the use of more mechanical, clearer tests that will enable profit-maximizing firms to better plan their production, purchasing, and investment strategies. [92] However, even though these rules represent a substantial advance over the existing system of multiple rules of origin which are applied differently for different purposes, application of these harmonized rules will not ensure harmonized origin determinations.

The Common Declaration with Regard to Preferential Rules of Origin, an annex to the Agreement (the "Declaration"), imposes a number of procedural safeguards similar to those discussed above, in hope of creating a more transparent, rule of law-like system for applications of preferential rules of origin. It requires that the rules be published. [93] It states that when issuing administrative determinations of origin, the requirements to confer origin be precisely and specifically stated, that requests by interested parties for an assessment of origin be made within 150 days, that such assessment be valid for three years, that the assessments be published, that they be subject to review by an independent body, and that the confidentiality of information submitted be protected. [94] However, it imposes few substantive limits on the preferential rules. It prohibits the use of negative standards of origin except to clarify a positive standard or when a positive determination is not necessary, and it prohibits the retroactive application of changes in preferential rules of origin. [95]

VII. Conclusion

Because decisions on rules of origin impact purchasing, sourcing, and investment strategies of profit-maximizing firms, it is imperative that they result from a transparent, de-politicized, and predictable process, so that firms can account for them as a factor of production when planning their profit-maximizing strategies. [96] A major step towards this goal has been taken with the Origin Agreement, which harmonizes the non-preferential rules of origin and attempts to create a more transparent, technical, predictable implementation process for all determinations of origin.

However, harmonization of the rules of origin is only a second-best solution. As long as countries continue to differentiate in the treatment of goods from different countries, i.e., to discriminate between different sources of supply of a product, rules of origin will continue to be a controversial, necessary, but inefficient device in international trade.


American Bar Association Standing Committee on Customs Law: Rules of Origin: Determining the Source of Goods for Customs Purposes (1991).

Asker, Paul: Changes in the Rules of Origin in the United States-Canada Free Trade Agreement: A Preliminary Evaluation, 36 Wayne L. Rev. 1545.

Asakura, Hironori: The Harmonized System and Rules of Origin, 27 J.W.T. 4, at 5-21 (Aug. 1993).

Beede, Harold: Note, The EEC Rules of Origin `Game': Can Non-Members Play?, 14 Suffolk Transnat'l L.J. 81 (Fall 1990).

Brooke, James: The New South Americas: Friends and Partners, N.Y. Times, April 8, 1994, at A3.

Cantin, Frederic and Andreas Lowenfeld: Rules of Origin, The Canada-U.S. FTA and the Honda Case, 87 Am. J. Int'l L. 375 (July 1993).

Choi, Chong Ju: Comment on Vermulst's and Waer's `European, Community Rules of Origin as Commercial Policy Instruments?', 25 J.W.T. 6, at 131-133 (Dec. 1991).

Galfand, C. Edward: Comment, Heeding the Call for a Predictable Rule of Origin, 11 U. Pa. J. Int'l Bus. L. 469 (1989)

General Agreement on Tariffs and Trade: Basic Instruments and Selected Documents, 2nd Supplement, 56 (1954).

Gerven, Gerwin: New Anti-Circumvention Rules In EEC Anti-Dumping Law, 22 Int'l Law. 809 (Fall 1988).

Herin, Jan: Rules of Origin and Differences Between Tariff Levels in EFTA and in the EC, Occasional Paper no. 13 (European Free Trade Association 1986).

Hoekman, Bernard: Rules of Origin for Goods and Services: Conceptual Issues and Economic Considerations, 27 J.W.T. 4, at 81-99 (Aug. 1993).

Hoekman, Bernard and Michael Leidy: Cascading Contingent Protection, 36 European Econ. R. 4, at 883-892 (May 1992).

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Jackson, John H.: World Trade and the Law of GATT (Bobbs -Merill 1969).

LaNasa, Joseph: Rules of Origin under the North American Free Trade Agreement: A Substantial Transformation into Objectively Transparent Protectionism, 34 Harv. Int'l. L.J. 381 (Spring 1993).

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Legierski, Renee: Note, Out in the Cold: The Combined Effects of NAFTA and the MFA on the Caribbean Basin Textile Industry, 2 Minn. J. Global Trade 305 (Summer 1993).

Maxwell, Michael P.: Formulating Rules of Origin for Imported Merchandise: Transforming the Substantial Transformation Test, 23 Geo. Wash. J. Int'l L. & Econ. 669 (1990)

McQueen, Matthew: Lome and the Protective Effect of Rules of Origin, 16 J.W.T.L. 2, at 119-132 (Mar./Apr. 1982).

Palmeter, N. David: Rules of Origin in Customs Unions and Free Trade Areas, in Regional Integration and the Global Trading System, edited by Kym Anderson and Richard Blackhurst (St. Martin's Press 1993).

Palmeter, N. David: The U.S. Rules of Origin Proposal to GATT: Monotheism or Polytheism?, 24 J.W.T. 2, at 25-36 (April 1990).

Palmeter, N. David: Rules of Origin or Rules of Restriction? A Commentary on a New Form of Protectionism, 11 Fordham Int'l L. J. 1 (1987).

Ruigbrok, Winfried: Paradigm Crisis in International Trade Theory, 25 J.W.T. 1, at 77-89 (Feb. 1991).

Simpson, John P.: North American Free Trade Agreement - Rules of Origin, 28 J.W.T. 1, at 33-41 (Feb. 1994)

Steinberg, Richard H.: Antidotes to Regionalism: Responses to Trade Diversion Effects of the North American Free Trade Agreement, 29 Stan. J. Int'l. L. 315 (Summer 1993).

Vermulst, Edwin: Rules of Origin as Commercial Policy Instruments - Revisited, 26 J.W.T. 6, at 61-103 (Dec. 1992).

Vermulst, Edwin and Paul Waer: European Community Rules of Origin as Commercial Policy Instruments?, 24 J.W.T. 3, at 55-99 (June 1990).

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Cases, Regulations and Statutes

Anheuser-Busch Ass'n v. United States, 207 U.S. 556 (1908).

Belcrest Linens v. United States, 741 F.2d 1368 (Fed. Cir.1984).

Brother Industries v. Commission (Case 229/86) ECR 3757.

Commission Regulation 288/89 on determining the origin of integrated circuits (1989).

Commission Regulation 802/68 on the common definition of the concept of the origin of goods (1968).

Commission Regulation 861/71 on determining, the origin of tape recorders (1971).

Commission Regulation 2071/89 on determining the origin of photocopying apparatus incorporating an optical system or of the contact type (1989).

Commission Regulation 2632/70 on determining the origin of radio and television receivers (1970).

Commission Regulation 3620/90 on determining the origin of the meat and foals, fresh, chilled or frozen, of certain domestic animals (1990)

Commission Regulation 3672/90 on determining the origin of ball, roller or needle roller bearings (1990)

Commission v. United Kingdom (Case 100/84) ECR1169.

Country of Origin Rules Regarding Imported Textiles and Textile Products, T.D. 90-17, 24 Customs Service Bulletin 3, 6 (March 14, 1990)

Criminal Proceedings against Cousin (Case 162/82) ECR 1101.

Data General Corp. v. United States, 4 Ct. Int'l Trade 182 (1982).

Ferrostaal Metals Corp. v. United States, 664 F. Supp. 535, 538 (Ct. Int'l Trade 1987)

Hartranft v. Wiegman, 121 U.S. 609 (1887)

Mast Industries v. Regan, 596 F. Supp. 1567 (Ct. Int'l Trade l986).

Midwood Industries, Inc. v. United States, 313 F. Supp. 951 (Cust. Ct. 1970)

National Juice Products Ass'n v. United States, 628 F. Supp. 978 (Ct. Int'l Trade l986).

SR Industries v. Administration des Douanes (Case 385/85) ECR 2929.

Superior Wire v. United States, 669 F. Supp. 472 (Ct. Int'l Trade 1987), aff'd, 867 F.2d 1409 (Fed Cir. 1989).

Textiles and textile products country of origin, 19 C.F.R. § 12.130.

Torrington Co. v. United States, 764 F.2d 1563 (Fed. Cir.1985).

Uniroyal v. United States, 542 F. Supp. 1026 (Ct. Int'l Trade 1982), aff'd per curiam, 702 F.2d 1022 (Fed. Cir. 1983).

United States v. Gibson-Thomsen Co., 27 C.C.P.A. 267 (1940).

Yoshida Kamer Van Koophandel en Fabriekn voor Friesland (34/78) ECR 115.

Yoshida v. Industries und Handelskammer Kassel (Case 114/78) ECR 151.



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