USMCA is Now in Force: Important Changes from NAFTA

| 19 minutes

Introduction

On July 1, 2020 the United States-Mexico-Canada Agreement (“USMCA”, and sometimes referred to as “CUSMA” in Canada and “T-MEC” in Mexico) finally came into force, replacing NAFTA after three years of negotiations, drafting, and revisions. While NAFTA has been described by President Trump as “perhaps the worst trade deal ever made”, the president lauded USMCA as “the largest, fairest, most balanced, and modern trade agreement ever achieved”. The text of the agreement, certain highlights, and other resources can be accessed on the Government of Canada’s website. Additionally, the Canada Gazzette published a series of orders and regulations on July 22nd to implement USMCA, including regulations on rules of origin and Tariff Preferences.

Although USMCA aims to preserve the tariff-free market access present under the former NAFTA, it includes a number of important updates. Importers, exporters, and producers should particularly take note of the differences between the two agreements in order to track how their business may be impacted. For some doing business in or with the North American region, the changes may not be significant, while for others, they will have a potentially massive impact on their supply chain and market access. This article will highlight major changes that took effect on July 1, 2020.

Rules of Origin

A key component of any free trade deal when it comes to trade in goods is the determination as to whether your goods qualify for duty free access or other preferential treatment when exported to a trading partner. Changes to the rules of origin under USMCA for preferential tariff treatment can be broken down into two primary categories: updates to the general rule of origin principles, and new product-specific rules.

General Principles and Methods

The principles and methods for determining country of origin under USMCA are generally similar to those found in NAFTA. However, there are some changes that may provide importers and exporters with additional flexibility.

One of the most significant is the change in the “de minimis” requirement. There is an increase in allowable non-originating content (namely, content not produced in USMCA countries) of a good to 10% from 7% previously available under NAFTA. Effectively, under USMCA a good can have more “non-originating” content and still qualify for preferential tariff treatment. This could have a significant impact on certain manufacturers’ supply chains as it effectively represents an increase of over 40% in the amount of permitted non-originating content under NAFTA.

While the originating criteria under USMCA remains largely the same as that under NAFTA, there are some notable changes regarding Regional Value Content (“RVC”) rules. For instance, USMCA provides more flexibility for using non-originating materials in the production of a good. Specifically, the following may now be counted as “originating content” when calculating RVC:

  1. the value of any originating materials that was used in the production of the non-originating materials; and
  2. the value of processing non-originating materials.

USMCA has expanded the applicability of the transaction-value method, which is generally simpler to use, by reducing instances where the net-cost method is mandatory. For example, under USMCA the RVC of a good sold between related persons can be calculated on the basis of the transaction-value method.

There are also new rules for goods that are imported as sets. Under these rules, each good in a set must be originating for the entire set to qualify as originating. However, a set will still qualify as originating if the value of non-originating goods does not exceed 10% of the set’s value.

Industry-specific changes

Industry-specific changes to the rules of origin could be significant for a number of sectors, such as energy, automotive, or textile and apparel. Certain of those changes will be discussed in greater detail below. While it might seem that other industries can continue business as usual given that USMCA often appears to replicate the old NAFTA provisions, this will not always be the case. A closer look at Chapter 4 and the Trilateral Uniform Regulations (“Uniform Regulations”) may reveal tweaks to the language that could materially impact the ability to claim preferential treatment.

With this in mind, a comprehensive rules of origin analysis is recommended for all businesses who relied on NAFTA provision to confirm the status of their exports under USMCA. The Uniform Regulations provide useful guidance on how USMCA rules of origin will be interpreted and applied by customs authorities.

Certificates of Origin

NAFTA imposed a uniform certificate of origin used across Canada, Mexico, and the United States. This certified that the imported good qualified for preferential tariff treatment. USMCA has removed the NAFTA requirement to follow this prescribed format. Instead, USMCA now refers to a “certification of origin” which may be provided on an invoice or any other document (including the current certificates in use) provided that the document contains certain “minimum data elements” listed under Annex 5-A.

Further flexibility is provided by the fact that USMCA now allows certifications of origin to be completed, signed, and submitted electronically. As well, the statement can be completed by either the exporter, importer, or producer. By contrast, under NAFTA, certificates of origin were required to be completed by the exporter, while a producer could provide a certificate to the exporter to verify a good’s origin, on which basis the exporter could issue their certificate.

Advanced Rulings on Origin

NAFTA allowed importers and exporters to obtain advance rulings on the origin of a product and its applicable tariff treatment. USMCA continues to allow requests for an advance ruling. However, under USMCA, former NAFTA rulings are no longer valid. As a result, new applications must be submitted to obtain an updated USMCA advanced ruling on the origin of a traded good.

Express shipments

USMCA provides for specific customs procedures designed to expedite express shipments. These provisions, which encompass a number of measures including submission of required information before the shipment arrives, electronic format, “minimum documentation”, and immediate release, are applicable to shipments valued at less than CAD $3,300 for Canada and USD $2,500 for the United States and Mexico.

Moreover, as one of the express shipment measures, Canada has increased the de minimis threshold for imports that are exempt from duties and taxes. This threshold was previously CAD $20 under NAFTA. Under USMCA, no duty or tax will be levied on products that are imported with a total value of under CAD $40. As the Canada Border Services Agency clarified in its Notice, this exemption applies to all goods imported into Canada from the United States or Mexico regardless of their originating status. If the item is sold for more than CAD $40 but less than CAD $150, other taxes (such as excise taxes and any HST, GST, or PST as applicable) are applied but custom duties are still waived.

Notably, this change could ease e-commerce sales to Canadian consumers. The above de minimis threshold is applicable provided that the shipment does not form part of a series of shipments carried out or planned for the purpose of evading duties or taxes.

Dispute resolution

Panel Blocking in State-to-State Dispute Resolution

USMCA is positioned to strengthen state-to-state dispute resolution. Under Chapter 20 of NAFTA, a party could block the formation of a panel by failing to participate in a meeting of the Free Trade Commission of Ministers for approval of a panel, or through a veto on updates to a roster of panelists. As a result of these loopholes, no panel had been successfully composed since 2000, when the United States blocked the selection of a panel in a dispute with Mexico.

Under USMCA Chapter 31, the role of the Free Trade Commission of Ministers is removed and panels are established upon request. If no consensus is reached on the roster within one month, it will automatically be formed from the proposed members.

Investor-State Arbitration

NAFTA was one of the first major trade deals to allow investors to sue governments for damages arising out of violations of investment protection obligations under the agreement. The investor-state dispute settlement mechanism (“ISDS”) is now available under USMCA only as between Mexico and the United States, as Canada and Canadian investors have been removed. Chapter 14 of USMCA sets out that ISDS under the original NAFTA may apply to Canada and Canadian investors only with respect to legacy claims regarding existing investments. This includes any investments established or acquired between January 1st 1994 and June 1st 2020. Such claims can be brought within three years after USMCA came into force.

Even though under USMCA there will be no ISDS between Canada and the United States, Canadian investors may sue Mexico and Mexican investors may sue Canada under the investment protection provisions of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership.

State-to-state arbitration provisions under USMCA Chapter 31 remain available to all three NAFTA governments. Under these provisions, a government may bring a claim against another USMCA member on behalf of one of its investors (provided the claim falls within the scope of Chapter 31). Whether the government will employ this option to protect Canadian investors operating in the United States remains to be seen. Likewise, the only recourse available to U.S. investors will be state-to-state dispute settlement, if the U.S. government chooses to bring a claim against Canada on a U.S. investor’s behalf. However, if successful, such claims would not result in any award for damages. Rather, under the Chapter 31 Dispute Settlement regime, a panel presents a report following the initiation of a claim to detail whether there has been a failure by one party to carry out its obligations under the agreement. If the report finds such a failure, the disputing parties must endeavor to agree on a resolution to the dispute. Where the parties do not agree on a resolution, the complaining party may suspend the application to the responding party of benefits that are equivalent in effect to the non-conformity.

Labour Protections

Chapter 23 of USMCA sets out essential labour rights, including freedom of association, collective bargaining, elimination of forced labour, and obligations with respect to the rights of migrant workers. The aim is to ensure parties to the agreement do not lower their labour protections to attract investment.

There is increased flexibility to pursue labour violations under USMCA’s Chapter 31 dispute resolution process. Importantly, such violations are presumed to affect trade or investment between the parties unless otherwise demonstrated. Additionally, Canada and Mexico established a “facility-specific, rapid-response labour mechanism” for enforcement, under which a party (the Government of Canada or Mexico) may request investigation into alleged labour violations. The investigation is conducted by an independent panel of labour exports. If a violation is found to exist, penalties can be imposed on exports from the offending facility.

Environmental Protections

Chapter 24 of USMCA aims to ensure parties do not lower environmental protections in order to attract trade or investment. It recognizes existing commitments of the parties under various multilateral environmental agreements. It also introduces new commitments to address illegal wildlife trade, illegal fishing and depletion of fish stocks, species at risk, conservation of biological diversity, ozone depletion, marine pollution, and commitments to improved air quality.

As with the new labour protections, there is increased flexibility to pursue environmental violations under USMCA. The burden of proof is reversed such that a violation is presumed to affect trade and investment between the parties unless otherwise demonstrated.

Additionally, any non-governmental organization or person established or residing in Canada, Mexico or the United States may file a submission on enforcement matters with the Commission for Environmental Cooperation. The result of the process is the formation of a factual record which publicly sets out the actions and background surrounding the alleged non-enforcement.

Industry Specific Changes

Many of USMCA’s key changes are sector-specific and impact a wide range of industries, including automotive, aluminum and steel, chemicals, textiles and apparel, oil and gas, food and agriculture, intellectual property, and technology. These are briefly summarized below:

Automotive sector

USMCA rules of origin for the automotive industry were at the core of the negotiations. As a result, of all sectors across the North American economy, the automotive industry faces the most significant changes under USMCA compared to the regime that existed under NAFTA. The new rules, which are significantly more restrictive, are expected to have a lasting effect on the North American automobile market.

The regional value content requirement for the origin of auto products has increased from 62.5% to 75%. A new labour value content provision requires that 40% of the value of a passenger car (and 45% of a light truck) be made of materials, parts, and labour (including final assembly) produced by workers in a plant where the average hourly wage is at least USD $16. The agreement also requires that 70% of aluminum and steel purchased by a vehicle assembler must originate in North America in order for the vehicle to qualify as originating. These changes are expected to increase the price of vehicles in North America, and increase compliance costs for manufacturers. However, it may also provide a boost for the automotive parts, aluminum, and steel industries within the USMCA region.

Aluminum and Steel

The 70% origination rule for automotive vehicle manufacturers (see above) may promote aluminum and steel production in North America. Moreover, seven years after USMCA comes into force, all steel manufacturing processes must occur in one or more of the parties in order for the steel to qualify as originating. Metallurgical processes involving the refinement of steel additives will be excluded from this requirement.

In May 2019, separately from USMCA, Canada successfully negotiated the elimination of the section 232 steel and aluminum tariffs of 10% and 25% that the United States had imposed on Canadian aluminum and steel respectively. However, under the agreement negotiated at that time to lift the tariffs, the United States is able trigger a “snap-back” and levy duties if  “imports of aluminum or steel products surge meaningfully beyond historic volumes of trade over a period of time”. At present, this issue remains volatile.

Chemicals

There are significant changes in product specific rules of origin related to chemicals and allied industries. In particular, eight new rules have been introduced governing origination of goods under Chapters 28-38, including cosmetic and pharmaceutical products.

The rules include: a chemical reaction rule, a purification rule, a mixtures and blends rule, a change in particle size rule, a standards material rule, an isomer separation rule, a separation prohibition rule, and a biotechnological rule.

Textiles and Apparel Goods

USMCA preserves the “yarn forward” rule of origin existing under NAFTA, which requires that the production of yarn and all processes following occur in Canada, the United States or Mexico. However, this requirement is relaxed for niche, vegetable-based yarns and fabrics that are usually sourced from outside North America. USMCA also creates new origin rules and requirements for “secondary” textile components, such as sewing threads, narrowing elastics, and pocketing fabrics. These measures are aimed to encourage the use of these components in North American goods.

NAFTA Tariff Preference Levels (“TPLs”), which allow duty free treatment of specific volumes of non-originating products, are preserved under USMCA for textiles and apparels. TPLs allow for a non-originating quantity of products to receive duty-free treatment among USMCA partners. Unlike under NAFTA, TPLs are now exempt from the U.S. merchandise processing fee, which could benefit Canadian and Mexican exporters.

USMCA will also allow small amounts of non-originating materials to be used if the total weight of the material is less than 10% of the weight of the good. The total weight of elastomeric content must also not exceed 7% of the total weight of the good.

Oil and Gas

Provisions pertaining to energy goods are scattered across USMCA as opposed to the stand-alone energy chapter in NAFTA. These provisions regulate various aspects of energy goods and related activities, such as rules of origin, market access, national treatment, customs, services and investments, etc. USMCA also contains an enforceable bilateral Canada-United States side letter, which provides for increased transparency in the sector by detailing access to electric transmission facilities and pipeline networks.

USMCA no longer includes energy “proportionality clauses” that were once present under NAFTA. Under these clauses, no party could reduce the proportion of the export of energy products to the other party to divert, for example, these supplies for local markets. These clauses restricted the ability for Canada to control the level of oil and gas exports to other NAFTA parties and, essentially, gave the United States unrestricted first access to most of Canada’s oil and natural gas.

There are also important changes to rules of origin. Crude petroleum and oil can contain 40% non-originating diluent that is added for transportation purposes, and liquefied natural gas may contain 49% non-originating feedstock.

Agriculture

Under NAFTA, the United States was granted full market access for most agricultural products with the exception of supply managed goods, such as dairy, poultry, eggs, and margarine. Under USMCA however, Canada has agreed to provide increased access to these key supply-managed industries. For example, the United States is estimated to be able to export the equivalent of 3.6% of the Canadian dairy market up from an existing level of 1%. The change is set to expand U.S. market access for turkey, chicken, broiler hatching eggs and chicks, skim milk, and margarine.

Intellectual Property

Several notable provisions were added to USMCA that will affect intellectual property protections in Canada. Specifically, Canada will need to extend copyright protections to “life plus 70 years” for works of authorship (the protection at present is “life plus 50 years”). Canada is also required to provide a statutory scheme of pre-established damages for trademark infringements. These damages are required to “be in an amount sufficient to constitute a deterrent to future infringements and to compensate fully the right holder for the harm caused by the infringement”. While the Copyright Act provides for pre-established statutory damages, the Trade-marks Act does not.

Parties are also required to provide patent term adjustments to compensate patent applicants for any unreasonable delays in the processing of patent applications. Unreasonable delay includes at least a delay in the issuance of a patent of more than five years from the date of filing of the application, or three years after a request for examination of the application has been made, whichever is later.

Originally, USMCA proposed a 10-year date protection requirement for biological drugs, which is an extension from the current 8 year protection period provided in Canada under the existing Food and Drug Regulations. However, this two year extension has been removed. Amendments also removed a provision explicitly requiring that patents be made available for new uses, new methods, or new processes of using a known product. Nonetheless, it should be noted that new uses for known compounds have long been patentable in Canada since the Supreme Court’s ruling in Shell Oil Co. v Commissioner of Patents, [1982] 2 S.C.R. 536.

Canada must also establish criminal penalties and remedies with respect to altering/removing management information and the unauthorized and willful misappropriation of trade secrets. Although civil remedies are available in Canada for misuse of management information, there are no current criminal remedies. Finally, stronger measures are to be implemented to detect counterfeit trademarks and pirated goods in transit at the border.

The IP implications of USMCA is discussed in greater depth in our IP commentary USMCA: Four Important Changes to Intellectual Property Rights and USMCA: Amendments Remove Key Biologic and Patent Obligations.

Technology

USMCA provides further changes that will impact technology and digital trade. Custom duties on digital products, such as music and eBooks, are removed. Civil liability protections are extended to interactive computer services and content published on their platforms. Finally, data localization requirements are reduced for financial institutions, foreign investors, and foreign services.

Forward-Looking Measures & Restrictions

There are two further measures in USMCA that are novel to Canadian trade agreements: the creation of a so-called “sunset clause” and restrictions on entering into trade agreements with non-market economies.

Article 34.7 creates a mechanism requiring a periodic review of the terms of USMCA.  Without review and re-approval by the Parties, USMCA automatically expires after a 16 year period – hence the term “sunset clause”.  This automatic expiry is avoided through meetings and negotiations that begin in year six of the agreement through a joint commission with representatives from each Party.  The Parties are to discuss the current status of the deal, challenges, and potential future changes to address the current economic climate.  The goal would be for the heads of state of each Party to agree to a new 16 year term, with another review in six years.  If any Party dissents, negotiations are to immediately begin – the failure of which would lead to the automatic termination of the agreement.

This measure was a key political goal of the US negotiating team, though they publicly sought a shorter sunset period than the sixteen years provided for under Article 34.7.  One of the primary drawbacks of the provision is that it undermines the certainty that is meant to be established by USMCA to begin with – companies making major capital decisions may be wary of an agreement that appears to have planned obsolescence than one that is intended to be perpetual.

The second novel term, Article 32.10, creates a framework required before any USMCA Party enters into negotiations with any “nonmarket country”.  Parties seeking such negotiations must inform the other USMCA Parties of the intention to begin negotiations, and must provide periodic updates regarding progress and any concessions which may undermine those granted in USMCA.  Finally, it creates a mechanism to excise a country from USMCA if the provisions of 32.10 are not complied with.

While the term “nonmarket country” isn’t defined, this clause received much media attention as being targeted at precluding Canada and Mexico from negotiating a free trade agreement with China.  Many more sensationalist voices declared that this clause was an affront to Canadian sovereignty, and allowed America to set our economic foreign policy.

The truth of the matter is that the clause is largely window dressing designed to placate bellicose voices in the Trump administration with strong anti-China views.  In reality, any negotiation with China would almost certainly require careful coordination with other partners, including the United States.  In fact, while the provisions are oft ignored, most free trade agreements (including the USMCA) require informing other Parties of negotiations of agreements with any other state which may impact the rights and concessions under the existing agreement. 

But more significantly, for both this concern and the concerns regarding certainty due to the sunset clause, the USMCA is already easy to exit.  Article 34 provides any Party the right to withdraw with only six months’ notice and without any justification.  Even if Article 32.10 did not exist, if Canada announced it had concluded a secret trade agreement with China, it is highly likely the Trump administration would announce termination of the deal through Article 34 immediately.  Clauses like 32.10 and 34.7 all create processes and guidelines for the Parties to follow to avoid unexpected and disproportionate reactions.

Transitioning Forward

USMCA officially entered into force on July 1, 2020, when it completely replaced NAFTA with no general transition period. Nonetheless, certain exceptions exist. For example, Canada has two-and-a-half years to implement changes respecting the general term of copyright protection and four-and-a-half years to modify patent terms to compensate applicants for “unreasonable delays in processing applications”. Moreover, as was mentioned above, although investor-state arbitration is weakened, investors have three years to commence a legacy investment claim.

U.S. Customs and Border Protection has established an “USMCA Center” to serve as a “one stop shop” for information regarding USMCA. The center aims to ensure smooth transition with guidance to internal and external stakeholders. Specifically, the agency can be contacted at a USMCA-dedicated email address with any inquiry if resources available online do not address stakeholder questions. While the Canada Border Services Agency does not have a similar service, it has pooled various resources and guidance documents for importers here.

With USMCA having finally come into force, the terms of free trade among Canada, United States, and Mexico have changed. Even so, the full impact and details of the implementation process remain to be seen. In the meantime, importers, exporters, and producers should continue to review to determine which key changes will impact their business as North American markets begin to adjust to these new rules of trade.

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