TRADE POLICY RESEARCH CENTRE: RESEARCH PAPER
By Ronald Stewart-Brown & Felix Bungay
When two or more countries form a free-trade area (FTA), they agree to eliminate duties on substantially all merchandise trade “originating” in that area but retain complete control of their trade relationships with other countries. FTA agreements are commonly known as free trade agreements. Many are “comprehensive” in the sense that they also cover trade in services, trade-related aspects of intellectual property and other aspects of trade relationships between countries.
“Rules of origin” are required to determine whether an individual product has originated in a free-trade area. They specify the minimum level of processing or manufacture that every merchandise category that would otherwise be subject to tariffs must have undergone to qualify for duty-free trade. The need for rules of origin in free trade agreements was first recognised in 1958 when the UK and other countries which would eventually form the European Free Trade Association (EFTA) were in talks about an FTA with the nascent European Economic Community (now the EU). Carefully negotiated rules of origin lay at the heart of the EFTA agreement when it was finally signed in 1960.
The EU has one standard set of rules of origin for both its European Economic Area (EEA) Agreement (1992) with Norway, Iceland and Liechtenstein and also for its free trade agreements with Switzerland, other European countries and certain non-European countries such as Egypt, Israel, Jordan, Lebanon, Morocco and Tunisia. These are contained in HM Revenue & Customs Notice 828 (December 2010), which is available online through Google.
The table below shows examples from this Notice together with applicable tariff rates for a wide range of tariff lines. Rules of origin are typically expressed in terms of maximum imported content (known as “non-originating materials”) as a percentage of ex-works price, of “sufficient transformation” or of specified processing stages that must have been undergone within the area compromising the EU, the EEA and their FTA partner countries. They are technical in language, complex and often difficult for even experts to understand. The principal technical terms are explained in the Glossary below.
The process of adapting to rules of origin-based duty-free trade under a new UK-EU free trade agreement would be tedious, costly and disruptive to trade. This might be acceptable to many British-owned manufacturers in the context of a return to UK self-government. But the prospect of loss of free movement of goods would probably be unacceptable to a number of important and largely foreign-owned UK manufacturing sectors such as cars, chemicals and processed foods. And it would certainly be unpopular with most continental exporters to the UK.
|Ad Valorem (AV) Tariff||An Ad Valorem (AV) Tariff is a tariff expressed as a percentage of the invoiced costs of an imported product.|
|Non Ad Valorem (Non AV) Tariff||A Non Ad Valorem (Non AV) Tariff is a tariff expressed as an amount in euros per unit weight of imported product.|
|Tariff Heading||A four digit code (heading in the table below) for a given group of categories of product (e.g. tariff heading 8504: power supply units for automatic data-processing machines) for which an individual EU rule of origin is specified in HMR&C Notice 828. Tariff headings are grouped into individual Chapters of the Notice by their first two digits.|
|Tariff Line||A six or eight digit code for a given category of product for which an individual tariff rate is specified. Zero tariff rates apply for over half the EU’s imports by value.|
|Ex-Works Price||The ex-works price of a product includes the value of all supplied materials used in its manufacture; all costs (material costs as well as other costs) effectively incurred by the manufacturer; and profit.|
|Non-Originating Materials||Non-originating materials can normally be regarded as raw materials, ingredients, components, parts, etc. which have been imported into the EU or its FTA partner countries for further processing or for inclusion in a finished product. However, the term also applies to any materials used to manufacture a product which does not meet the wholly produced or sufficiently transformed criteria.|
|Materials||"Material" means any non-originating material unless otherwise indicated.|
|Originating Products||Originating products are products which have either been "wholly produced" in the EU and its FTA partner countries or which comply with the applicable rules of origin for their tariff headings.|
|Sufficient Transformation||A finished product is normally considered to have undergone sufficient transformation when it is classified under a different 4 figure tariff heading from those of all the non-originating materials incorporated in that product.|
|Wholly Produced Products||Products are considered to be wholly produced (or "obtained") in a Member State of the EU or one of its FTA partners if no other country has been involved in their production. The smallest addition of materials or processing in another country will normally disqualify a product from being wholly produced. This means that manufactured products will rarely meet the wholly produced criteria. There is a tolerance for non-originating materials of 10% of the ex-works price of the product in the case of most food products.|
|Cumulation||Complex rules exist for cumulation of origin where a product finished in one country within the area comprising the EU, the EEA and their FTA partner countries contains materials which originated in, or were partly processed in, one or more other countries within the area. Cumulation may be "bilateral, "diagonal" or "full", as defined in Notice 828 (December 2010).|