Understanding Rules of Origin under the Brexit Agreement
The UK-EU Trade and Co-operation Agreement (“TCA”) provides businesses with the benefit of tariff free and quota free trade in goods between the two trading blocs.
Many may not realise, however, that these benefits can only be reaped with effort on the part of importers and exporters. One task to be fulfilled is proving that the goods to be imported or exported have “originated” in the EU or UK.
The origin of the good is its economic nationality, rather than the point from which it is exported. One of the purposes of the rules is to ensure that goods which are actually from outside of the UK and EU do not enjoy the benefits of the TCA by entering the territory of either party and being exported from there. This prevents, for example, the import of goods from third countries with low labour protection standards and their circulation to the UK – EU trade area, which would cause distortions of competition.
There are detailed rules – rules of origin – set out in the TCA which determine whether or not the goods do in fact originate from the other party. Rules of origin are common for any Free Trade Agreement. These rules – which are currently causing much vexation for companies – take up around 50 pages of the TCA.
The ease or otherwise of satisfying the TCA’s rules of origin will depend upon a number of factors. These include, for example, the complexity of the goods to be produced, the number of countries in which production take place and the quantities of components they incorporate. Manufacturers need to be able to show where all the parts come from. Complications arise where a good is clearly produced in the UK or EU but contains components which have originated in a third state (e.g. car components sourced from Japan). The early indications are that for a number of companies, complications are emerging. Features of their production process may be preventing them from enjoying tariff free treatment under the TCA.
Rules of Origin – basic principles
Chapter 2 of the TCA lays out the detailed Rules of Origin. These begin with a statement of some general principles. Later in the chapter, the TCA sets out detailed rules for specific types of products, such as for electronic vehicles.
Article ORIG 3 provides that “for the purposes of applying the preferential tariff treatment by a Party to the originating good of the other Party in accordance with this Agreement, the following products shall be considered as satisfying the originating rules:
(a) products “wholly obtained” in the EU or UK within the meaning of Article ORIG.5 [Wholly obtained products]. Article ORIG.5 sets out the specific situations of when goods will be deemed to have been “wholly obtained”. This applies, for example, in relation to agricultural goods which have been grown entirely in the country concerned;
(b) products produced in the EU or UK exclusively from originating materials from the EU or UK; and
(c) products produced in the EU or UK incorporating non-originating materials provided they satisfy the requirements set out in ANNEX ORIG-2 [Product-specific rules of origin].
Unfortunately, these three basic principles are not the full extent of the TCA Rules of Origin. Other rules and principles in relation to the production and process, some of which are now discussed.
Rules on processing and “insufficient production”
If a product has acquired originating status, the non-originating materials used in the production of that product shall not be considered as non-originating when that product is incorporated as a material in another product.
Notwithstanding the product-specific rules in Annex ORIG.2, a product will not be considered to be “originating” if the production of the good consists only of certain specific operations listed in Article ORIG.7, which are deemed to constitute "insufficient production".
These include, for example, breaking-up or assembly of packages, and affixing or printing marks, labels, logos. Although this is a typical FTA provision, it is likely to create acute problems in the context of UK-EU trade. For example, within the food industry, it has become common for foodstuffs to be imported into the UK from one EU member state, to be stored in a distribution hub and then forwarded on to another EU member state. Carrying out this practice in future could attract tariffs.
The BBC reported challenges faced by Marks and Spencer in their production of Percy Pig sweets. The sweets are manufactured in Germany and then shipped to the UK. They are stored here then exported onwards to Ireland. At this point, even though the goods started off in Germany, they are effectively being exported back into the European Union. That means that they could attract tariffs, as they are not considered as “originating” within the UK. They have only been stored in the UK, which qualifies as “insufficient production” under Article ORIG.7 so do not benefit from the cumulation rules discussed above.
Rules on tolerances
Article ORIG.6 Provides certain “tolerance” rules. These are basically allowances for non-originating materials within the product up to a specified threshold. If the quantity is below the specified amount, the good will still be considered to be “originating”. Examples of tolerance rules include a sub-provision stating that “originating” status will not be lost if the non-originating materials carry a value below 10% of the ex-works price of the product.
Another feature of the rules is “bilateral cumulation”. Cumulation is the term used to describe a system that allows originating products of country A to be further processed or added to products originating in country B, just as if they had originated in country B. Bilateral cumulation operates between two countries where a preference agreement contains a provision allowing them to cumulate origin. Materials originating in either country in the preference agreement will be considered as materials covered by the rule of origin.
In the context of the TCA, Article ORIG.4 provides that “a product originating in a Party shall be considered as originating in the other Party if that product is used as a material in the production of another product in that other Party”. This helps to reduce disruption to existing EU-UK supply chains.
Production carried out in a Party on a non-originating material may be taken into account for the purpose of determining whether a product is originating in the other Party. However, the principle of cumulation will not apply if the production does not go beyond the types of production set out at Article ORIG.7 [Insufficient production].
It is also worth noting that the TCA rules out “diagonal” cumulation. That occurs where there is cumulation in a third state with whom both parties have Free Trade Agreements. The obvious example is Japan. A manufacturer who imports inputs from Japan, taking advantage of the tariff free treatment under the UK-Japan Comprehensive Economic Partnership Agreement may face tariffs when exporting the finished product to the EU.
The TCA imposes obligations on exporters to complete the necessary paperwork and retain this if requested by a customs authority. Failure to complete information on origin properly could prevent the shipment of the goods.
Completing the paperwork to demonstrate origin is often very difficult. It has been reported that certain companies are opting to pay tariffs because completion of the necessary forms is extremely onerous, in some cases to the extent of being impracticable. Mention was made above of the particular difficulty of showing where all the component parts of a manufactured item have come from.
Conclusions – rules for a new economic reality
Companies who export outside of the European Union will already have had exposure to rules of origin. Now a wider section of the business community is being exposed to these and to the often painful experience of understanding how they apply to particular types of goods.
As the Marks and Spencer story illustrates, the manner in which goods cross frontiers through the various phases of production and pass through the supply chain can have an impact on whether or not the goods are considered “originating”, thus retaining the benefit of tariff free status. With this in mind, businesses should consider how their supply chains and production processes work, as well as considering whether any aspect of these should be changed in order to secure exemptions from tariffs. On the other hand, an analysis is needed of the complexity of completing the necessary paperwork. In some instances, the time costs of completing onerous forms may exceed the benefit of avoiding the applicable tariff. Tariff levels vary for different types of goods, so it is worthwhile ascertaining the applicable charge.
Please contact your usual Charles Russell Speechlys advisor if you have any queries regarding Brexit, the construction industry or what it means for your business.