5 minute read 16 Nov 2018
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How ‘NAFTA 2.0’ brings some clarity about trade in the Americas

By

Gijsbert Bulk

EY Global Director of Indirect Tax

Seasoned indirect Tax Partner. Serving clients in Amsterdam and beyond. Litigator. Husband. Father of four boys. Chess player. Runner.

5 minute read 16 Nov 2018
Related topics Tax US tax reform Supply chain

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As USMCA trades places with NAFTA, it brings the promise of greater clarity for business in terms of supply chains and tax planning.

US President Donald Trump repeatedly called the North American Free Trade Agreement (NAFTA) the “worst trade deal ever made.” However, on 30 September, after more than a year of negotiations, he, Canadian Prime Minister Justin Trudeau and Mexican President Enrique Peña Nieto have unveiled NAFTA 2.0 or, as the US prefers to call it, the United States-Mexico-Canada Agreement (USMCA).

The deal, which still needs to be signed and passed through Congress before it enters into force, likely in 2020, is something of a relief in the midst of America and China’s increasingly serious trade dispute.

While it’s true that imports of steel, aluminum, solar panels and washing machines still attract tariffs – even those from Canada and Mexico – USMCA does a least give companies some clarity about the future.

Michael Leightman, EY Global Trade Practice’s Trade Reform Initiative Leader, says: “At least there is now some certainty in terms of trade planning and alternatives to consider ¬– whether that is shifting production into the US or from other countries into Mexico and then on to the US market under the qualifications of the new trade agreement.”

Dalton Albrecht, EY Global Trade Leader in Canada, says: “USMCA will help stabilize things, but nobody really knows where these tariffs are going and to what extent you can make plans. There are certain general things we look at, though, such as can you get remissions of duty (refunds or advance duties relief) and what about alternative-sourcing planning? Can you change supply chains for different destinations for the goods?”

Leightman and Albrecht also advise that companies carefully consider the tariff classification and declaration of origin. Under USMCA there are rules of origin that stipulate what percentage of inputs imported from elsewhere are permitted for goods. For example, 75% of the key components in cars will have to come from the country of origin; i.e., US, Canada or Mexico under the deal.

Armando F. Beteta, leader of the EY Global Trade services at the Latin American Business Center, says: “The new rules included under the USMCA for the automotive industry are particularly important for Mexico. While the rules of origin for this industry are clearly more strict and new requirements have been added (i.e. 70% of aluminum and steel should be from North America and a high wage labor value content). There are also interesting incentives linked to the agreement via side letters that, for example, will waive for a high number of Mexican autos/autoparts any potential punitive tariffs, if these are imposed by the US under Section 232 in the near future.”

Leightman says: ”We are seeing an increase in jurisdictional enforcement where customs are looking closer in each country at the qualifications, the documentation, the information submitted to ensure that companies are complying with the rules. In a broader context, across the globe we are also seeing an increase in inspections and requests for data and information on declarations, so we recommend that regulatory and compliance divisions are involved proactively and not reactively.”

He adds: “Companies need to ensure they are using the lowest duty values legally permissible from a customs declaration perspective and that they are looking to see if they can reduce the value of intangibles included in the duty value.

“There are a number of strategies that companies might use in the duty deferral area, such as bonded warehouses or free trade zones. Then there is the drawback potential where you can reclaim some of the costs of duty and trade flow costs. So there are a variety of different options to at least reduce impact if you are not able to find alternative sourcing for certain products,” says Leightman.

In a poll of 600 tax executives by EY almost a quarter of companies, 24%, were looking at duty drawbacks and/or the use of free trade zones to mitigate the effects of tariffs.

EY survey of tax executives, October 2018

24%

of respondents' companies were looking at duty drawbacks and/or the use of free trade zones to mitigate the effect of tariffs.

The US did design provisions to allow companies in certain industries that are affected by the duties to request exclusions or exemptions where specific circumstances are warranted such as unavailability of a particular item in the US. However, as these provisions have stringent requirements, they are not easily achieved. For the steel tariffs, as an example, to date there has been an approximate 50 to 55% approval rate for requests for exclusion, granted for a year, after which companies have to reapply.

However, while the US has also provided exclusion provisions for the tariffs imposed on China origin goods, it is anticipated that only 10 to 15% of exemptions for Chinese products will be approved. “The tariff on Chinese products was designed to try to demonstrate the need for companies to locate other sources, so tariff exemptions or exclusions are only being granted where the tariff will be more harmful than helpful in the administration’s view,” says Leightman.

Mike Heldebrand, EY Global Trade Leader for US West Region, says that boards are well placed to understand the implications of USMCA. “From a C-suite perspective, what is interesting is that the US introduced something, about a year ago, called the border-adjustment tax (destination-based cash flow tax) so you had a very high level of executives involved in that, inputting values that they had never had insight of previously. The introduction recently of additional tariffs has elevated trade practitioners from technical advisors to strategy advisors. This shift has brought them higher visibility in business planning.”

Tax specialists deserve their place at the top table, according to Ute Benzel, EY EMEIA Tax Leader, who says: “My advice to board members would be to go into the discussion early and be part of it. If you are head of tax, sit in the driving seat. Make sure that you follow what’s going on that is relevant to your business in trade and tariffs. Try to make sure you have the right supply chains and the right delivery models to fit the new rules.”

My advice to board members would be to go into the discussion early and be part of it. If you are head of tax, sit in the driving seat. Make sure that you follow what’s going on that is relevant to your business in trade and tariffs. Try to make sure you have the right supply chains and the right delivery models to fit the new rules.
Ute Benzel
EY EMEIA Tax Leader

Panel: Key differences between NAFTA and USMCA

Critics have dubbed USMCA “NAFTA 2.0,”, saying that little has changed since the original agreement but there are fundamental additions.

Automotive industry

The agreement states that 30% of vehicle production must be done by workers in factories where the average wage is at least $16 an hour. In 2023, this rises to 40% of workers. Auto workers also have the right to labor union representation.

Also, 70% of the steel and aluminium used in vehicles will have to come from the US, Canada or Mexico.

Manufacturers qualify for zero tariffs if 75% of their vehicles’ components are manufactured in the US, Canada or Mexico – it was 62.5% under NAFTA. If the US imposes section 232 national security interests tariffs on autos, Mexico and Canada will be able to export up to 2.6 million vehicles to the US each year tariff-free. 

Not qualifying for the new terms is arguably not the end of the world, especially those involving US sales, because US tariff rates are a low 2.5%, says James Mackie, Co-Director of the EY Quantitative Economic and Statistics (QUEST) group.“In some cases, it could cost more to comply with NAFTA – for example, because of the complexity of meeting wage requirements for autos – than it’s worth,” says Mackie.

In some cases, it could cost more to comply with NAFTA – for example, because of the complexity of meeting wage requirements for autos – than it’s worth.
James Mackie
Co-Director, EY Quantitative Economic and Statistics (QUEST)
Dairy farming

American farmers will be able to export about $560 million of dairy products to Canada for the first time.

Metal tariffs

US national security interest safeguard tariffs of 25% on steel and 10% on aluminum from Canada and Mexico remain.

Intellectual property

For first time, law enforcement officials can stop suspected counterfeit or pirated goods in any of the three countries, with harsher punishments for pirated movies online.

Evergreen clause

If the deal starts, as expected, in 2020 it may last at least 16 years, with a review every six years and an option to extend it to 2042.

Summary

The United States-Mexico-Canada Agreement (USMCA) offers organizations much-needed clarity on the future. The agreement replaces NAFTA, a document US President Donald Trump called the “worst trade deal ever made.” One of the main changes is an increase in jurisdictional enforcement to ensure companies comply with the rules, which means that regulatory and compliance divisions need to be involved proactively rather than reactively.

About this article

By

Gijsbert Bulk

EY Global Director of Indirect Tax

Seasoned indirect Tax Partner. Serving clients in Amsterdam and beyond. Litigator. Husband. Father of four boys. Chess player. Runner.

Related topics Tax US tax reform Supply chain