Tax & Accounting Blog

The Rules of Origin Utilization Rates Under the Preferential Duty Scheme

Blog, Global Trade, ONESOURCE April 27, 2018

It is unquestionable that an in-depth examination and better understanding about preference utilization can provide useful insights about not only best practices in terms of Preferential Trade Arrangements, but also about its limitations. This article will focus on the limitations, as there are still many companies which operate in the international environment that don’t use the benefits allowed them through tariff preferences. There are also companies which use tariff preferences in a limited extent; demonstrated by the low level of preference utilization in many trade statistics.

This may be an indication that certain conditions faced by companies are reducing their ability to fully capture preferential opportunities. Of course, there are different factors that could also explain low utilization of preferences. Since the compliance with rules of origin is a central and obligational requirement to utilizing preferences, low preference utilization rates may indicate that origin requirements are overly strict and costly if declared incorrectly.

Limitations to the Use of Preference Utilization

Preference utilization impacts a portion of those imports which are actually being imported under preferences, versus those imports that are eligible for trade preferences. A preferential duty scheme can only be utilized if there actually is a preference tariff margin. In other words, tariff lines on which the rate is zero on a Most Favored Nation (MFN) basis, cannot offer preference. In such cases, preferential rules of origin (1) cannot stand as a trade barrier (2). As a result, MFN-zero tariffs are not taken into account for the calculation of preference utilization rates.

The decision that must be taken by companies in terms of trade preference usage is contingent on two main factors:

  1. Attractiveness: the greater the preferential tariff margin (the difference between MFN and the preferential tariff rates), the more likely it is that the company would seek to comply with all conditions to export under the preferential scheme;
  2. Compliance: the higher the cost, or complexity in maintaining compliance with the prescribed regulations and procedures – especially regarding the general or productspecific rules of origin (PSR) – the more difficult the decision process to adopt the preference utilization.

In terms of compliance factors and the impact that preferential rules of origin may have on preference utilization, the benefit granting process is based on four origin-related requirements:

  1. Compliance: the general or productspecific rules of origin must be reached (i.e. minimum criteria defining origin and substantial transformation);
  2. Traceability: the declarations of origin can track all materials provided by third partners in the manufacturing of the final product intended to export must be met;
  3. Certificate of origin: a document which is supposed to match specific requirements;
  4. Direct transportation: the ability to directly consign the goods from the beneficiary country to the preference granting country (i.e. to comply with the transportation requirements).

When all four requirements are met, the preference will qualify. Hence, low preference utilization could indicate that the rules under which a product can acquire the origin status are too demanding and often the headcount dedicated to the process is allocated elsewhere. It could also indicate that certificates are too costly to obtain, validity of information is deeply scrutinized, or that a company is not able to ship the goods directly to the market of the preference-granting country. On the other hand, a high utilization rate would indicate that origin requirements do not hinder trade and can be easily complied with.

Limitations to Measure the Level of Preference Utilization

It’s important to mention that the restrictions imposed by preferential rules of origin are not the only factor, which could be a factor in less-than-full utilization of preferences. For instance, trade preferences may not be utilized because the preferential margin is not sufficiently attractive. That is, the MFN rate is so low that the preferential margin does not work as an incentive to use the preferences.

Moreover, there are some overlapping issues in the various granting acts with preference duty schemes to the same country or region. Companies may have a choice between different preferential schemes, for example non-reciprocal and reciprocal; each with different rules of origin. The United States “African Growth and Opportunity Act (AGOA)” co-exists with the United States General System of Preferences (US GSP) as a perfect example to support the above point.

In the presence of such competing preferential schemes, companies will prefer to trade under whichever scheme is most beneficial and balance this decision with which may be easier to manage. As a result, low preference utilization under the US GSP may convey the wrong impression that the scheme is of little value for beneficiaries whereas exporters may prefer to use AGOA.

Likewise, Australia grants trade preferences to Cambodia under the Australian System of Tariff Preferences (ASTP) and under the ASEAN-Australia-New Zealand Free Trade Agreement (AANZFTA). Only a combined examination of trade under both schemes would enable a comprehensive overview of preferential trade patterns.

Preferential Trade and Preference Utilization Rates

Since 2015, we have seen a decline of total imports of each WTO preference-granting members from Least Developed Countries (LDC). This has been noted on a large proportion of global imports, under 4 specific conditions: MFN dutiable lines (not eligible for preferences), MFN-zero lines, under a Preferential Trade Agreements for LDC scheme (either utilizing or not utilizing the preferences); and under “other” preferences.

If a company can introduce a process that employs cost reduction and higher efficiencies, this can increase their bottom line and their overall brand competitiveness. We have found that the utilization of technology in managing this process can certainly assist in running an effective trade preference program and in minimizing the amount of money they are leaving on the table due to the underutilization of a preference duty scheme.

(1) The Committee on Rules of Origin from the WTO (adopted in 2016) provides the methodology of calculation, which compares the value of imports which were “reportedly” benefitted from preferences versus the value of total imports which would have been “eligible” for such preferences.

(2) Any regulation or policy that restricts international trade, especially tariffs, quotas, etc.

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