Expanding internationally offers businesses enormous potential for increased sales and market share. However, going global is not without its challenges and some of the most frequent obstacles to taking a business global are tariffs and other market access restrictions such as quotas and anti-dumping rules that are designed to protect the local market participants. For this reason, the nature of the trade relationship between the country in which you produce your products and the target country may be a significant factor in determining the viability of the new market.
Preferential Partners – Free Trade Agreements (FTAs) are treaties between two or more countries designed to reduce or eliminate certain barriers to trade and investment, and to facilitate stronger trade and commercial ties between participating countries. They create a basis forthe preferential treatment under the World Trade Organisation (WTO) rules. There are various forms of FTAs, including Free Trade Zones, Economic Partnership Agreements, Customs Unions, etc. – Bilateral Agreements (EU-Chile, US-Korea) or Regional Agreements (e.g. NAFTA, COMESA, MERCOSUR, ASEAN, GCC, EU-ACP EPAs, etc.). There are approximately 300 FTAs between various countries around the world with an average of eight FTAs for each country. A list of current FTAs can be found at WTO Regional Trade Agreements.
As the global supply chains become increasingly interdependent, determining where a product originates becomes increasingly difficult. However, determining the country of origin of a product is a key consideration for international trade and has a direct impact on market access. This is the case irrespective of whether an FTA is in place between the trading countries. The rules of origin (RoO) which apply to an international transaction are always that of the importing country as it is the importing country that sets the conditions for entry of goods into its territory.
Where an FTA is in place the countries involved will enjoy preferential treatment (i.e. reduction in tariffs or exemptions from other trade restrictions) and the relevant FTA will set out the applicable RoO for determining which products qualify for these benefits. The RoOcan be quite complex and present a challenge to small and medium sized enterprises due to their complexity and the administrative burden. The RoO requirements will vary between FTAs and between countries so it is important to ensure that each FTA you intend to rely on is thoroughly reviewed and understood.
Non-Preferential Partners – Where no FTA is in place the WTO non-preferential RoO will usually apply. The RoO in these cases is used for the purposes of other, non-tariff related, trade policy measures such as quotas, anti-dumping, food and health (sanitary) measures, etc. They are also used to indicate the country of origin on labels (consumer policies) and to collect trade statistics. Not all countries apply non-preferential rules of origin.
The WTO non-preferential RoO originate from the International Convention on the Simplification and Harmonization of Customs Procedures (commonly known as the Kyoto Convention). The Kyoto Convention specifies that the country of origin of a product is the country:
- where the commodity has been wholly produced (this concept is used when only one country is involved in the origin attribution), or
- where the last substantial transformation took place (this concept is used when two or more countries have taken part in the manufacturing process of the commodity).
According to the Kyoto Convention the last substantial transformation is the transformation that is deemed to be sufficient to give its essential character to a commodity. Such a broad definition offersa variety of interpretations and gives a country the freedom to specify the meaning of substantial transformation by themselves, which is reflected in import regulations.
To determine the last substantial transformation, three general rules are applied:
- Change of tariff classification (the CTC rule): A good has undergone a significant production process that changes its tariff classification. For tariff purposes, a product is classified according to the international Harmonized Commodity Description and Coding Systems (HS).The HS allows participating countries to classify traded goods on a common six-digit code basis for customs purposes. The HS comprises approximately 5,300 article/product descriptions that appear as headings and subheadings, arranged in 99 chapters, grouped in 21 sections. The six digits can be broken down into three parts. The first two digits (HS-2) identify the chapter the goods are classified in, e.g. 09 = Coffee, Tea, Maté and Spices. The next two digits (HS-4) identify groupings within that chapter, e.g. 09.02 = Tea, whether or not flavoured. The next two digits (HS-6) are even more specific, e.g. 09.02.10 Green tea (not fermented). A CTC that meets the substantial transformation requirements of the most ROOs is a 4-digitchange of the HS classification.
- Regional Value Content: A change in value, or at least 40 per cent of value-adding, has taken place within the relevant country. This is an option for some but not all products.
- Special processing rule: A good has undergone a specific process that fundamentally changes its nature. For example, a substance that undergoes a chemical reaction that transforms it but does not change its tariff classification or changes it sufficiently to apply the CTC rule. This is available for some products where the minimum transformation is described. For instance, in the EU non-preferential rules of origin for T-shirts (HS6109), the origin is supposed to be in the country where the complete making-upwas done. The complete making-up being the specific process for the purposes of import regulations.
Under the non-preferential RoO a product always has exactly one country of origin. However, the non-preferential RoO may differ from country to country and the same product may have different origins depending on which country’s scheme is applied.
For a business wishing to expand into a foreign market and irrespective of whether an FTA is in place, mastering the relevant RoO is only part of the battle. A business wishing to enter a foreign market must still develop an appropriate international business plan to address a wide range of issues, including:
- identify market opportunities,
- develop market entry strategies and appropriate distribution channels,
- overcome language and culture barriers, and
- local consumer protection and other regulatory requirements.
SMEs often require additional support in preparing cost-effective and viable market entry strategies in order to extract maximum value from new international markets. Arenburg Consulting has extensive experience in supporting SMEs to develop international business plans to expand or enter new export markets.