Is the complexity of trade rules keeping FTA benefits out of your reach?

With all the noise about tariff wars, free trade agreements and WTO rules, it’s clear that many people don’t actually understand global supply chains and their interactions with the various rules that govern regional and global trade. As with many modern problems, an answer can be found in Greek Philosophy – in particular, a great thought experiment known as ‘the ship of Theseus’.

As a ship leaves port it requires repairs at the next port and the next and so on until it reaches its destination with every board replaced. The question posed is this: Is the ship at the end of the journey, the same as the ship that departed? The experiment was an attempt to answer the question “when are you you?” As the human body is in constant growth and change, is it when you were born, at seven years of age, now or at your death?

Often, origin is in the eye of the beholder. Most consumers would consider the iPhone to be an American product, despite the Chinese assembly, Korean screen and bits and pieces from across Asia. Agricultural products are pretty straightforward when they stay in their original form. Oranges and almonds grown and harvested in Mildura, Northern Victoria, start as Australian products and remain Australian products despite packaging or the location of consumption.

When approaching Free Trade Agreement (FTA) negotiations, Trade negotiators focus on both the tariffs for individual products as well as the rules of origin. Final tariff rates receive a lot of attention from industry and media, however without practical rules of origin that reflect modern global supply chains, the benefits of some FTAs are lost, especially to those industries that rely on processes to add value, rather than materials.

Most FTAs rely on a rule of origin known as ‘Change of Tariff Classification’ – that is, showing substantial transformation of the product by changing the customs code of the input into a new product with a new customs code. As in the example below, a Malaysian vacuum cleaner manufacturer can import inputs from Germany, China and Japan and their finished product will meet the rule of origin to make use of the ASEAN Australia NZ Free Trade Agreement and enter the Australian market duty free. Because the imported components are material with individual tariff codes that are transformed into a new tariff code, it is very simple for the Australian Customs official to make the assessment that there has been substantial transformation of the imported components.

The problem with this process is that it doesn’t reflect the added value of processes, such as cutting, sewing, assembly or chemical processing, or the value of IP and marketing.

Let’s think about the country of origin of a pair of children’s pyjamas and imagine the following scenario:

An Australian clothing retailer, with outlets across Australia, Middle East and South East Asia, wants to take advantage of an unexpected internet sensation caused by a new animation character from Japan. As the window of opportunity may close as quickly as it opened, they decide to outsource the design of the pyjamas, using Australian creative marketplace Envato to find a designer. They quickly settle on a designer in the Philippines, send them a copy of the Australian standard (AS/NZS 1249:2014, Children’s nightwear) along with their other design requirements and approach the image owner in Japan to negotiate a licensing agreement. Designs completed, the retailer contacts their usual supplier in China; however, due to overcapacity, they are unable to finish the items, but agree to cut the material, which is made from Indian cotton, woven in China. The retailer’s supply chain manager finds a contact in Vietnam who can sew, label and pack the finished product.

So, what do you think is the country of origin?

Under Australian consumer law, they would be labelled ‘Made in Vietnam”, despite fact that the consumer is probably buying this particular pair because they have the image of the Japanese animation character and they are standing in an Australian branded shop. As Vietnam is a member of both the ASEAN Australia NZ FTA (AANZTFA) and the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (CPTPP), the importer has the option to try and use either agreement, saving 10% duty at the border.

Let’s look at how a customs official would evaluate the content and value-add of each country compared to how the real world might view it.

Country Real world contribution Customs contribution
Australia Concept generation

Connection to online database of creative professionals

Branding and intellectual property

finance

Product Standards

Distribution and Marketing

None
Philippines Design None
Japan Intellectual property None
India Cotton None – actually counts against the final product origin as India is not a member of AANZFTA or CPTPP
China Weaving fabric

Stamping design

Cutting fabric

None – actually counts against the final product origin as China is not a member of AANZFTA or CPTPP
Vietnam Sewing, packing and labelling. It’s complicated. Under the rules of origin, clothing must be cut or knit to shape, or both, and sewn or otherwise assembled in the country of export. So in this case: None.

 

This means that the retailer won’t be able to avoid paying 10% duty if they can’t wait to finish the product in China, where they could use the China Australia FTA, and the ASEAN China FTA for their stores in South East Asia.

Sound complicated? It is and can be a real barrier for companies trying to make use of FTAs that cut across regional supply chains. In a survey conducted by the East Asia Business Council on utilisation of the ASEAN Plus FTAs, it was found that complexity of Rules of Origin in existing FTAs was major bottleneck for FTA utilisation and 34.5% of the Electrical &Electronics industry and 29.4% of Textile industry have given up on using FTAs due to not being able to fulfil the relevant rule of origin for their product.

Trade Negotiators rely on input from businesses to ensure that the final outcome does reflect their supply chains, otherwise protectionist trade partners can put up barriers to trade through onerous rules that undermine any win there might have been on the tariff side. The final text of the Australia USA FTA meant that no Australian textile company was able to comply with the rules of origin, missing out on the zero tariffs we’d secured.

Ai Group is able to assist companies to map their current supply chain against Australia’s FTA architecture and help to maximise the benefits of our FTAs. Get in touch today to find out how we can help.

 

 

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Louise McGrath
Having joined Ai Group in 2000, Louise has managed a number of trade-related projects including trade missions, business matching and the development of export-related training programs. Since 2009 she has led Ai Group's service delivery to our smaller associations, providing governance, policy and business development support, and is Executive Officer of the Australia Saudi Business Council and the Australian Russian Dialogue.

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