Rules of Origin under the Australia–New Zealand 
Closer Economic Relations Trade Agreement

Australian Industry Group submission to the Productivity Commission

25 February 2004

CONTENTS

Summary	1

Background	1

The Productivity Commission Recommendations	2

The Ai Group Recommendation	3

Rules of Origin under the Australia-New Zealand Closer Economic Relations Trade Agreement (CER)

Submission to the Productivity Commission
By Australian Industry Group
25 February 2004

Summary

As stated in Ai Group’s original submission to the Productivity Commission on 10 October 2003, the overwhelming majority of Australian manufacturers are not seeking change to the Rules of Origin (ROO) under CER.

However, the Productivity Commission interim report identifies some problems with the operation of the ROO, which were particularly highlighted by New Zealand companies.

In accordance with the Productivity Commission’s analysis of these issues, Ai Group accepts the minor changes for immediate implementation proposed in its Recommendation 1, as an interim measure. 

Ai Group does not support either of the two options for substantial change proposed in the Productivity Commission’s Recommendations 2 and 3, namely:
•	applying a waiver (to the current 50% local content rule) to provide duty free entry for CER goods which have trans-Tasman tariff differences of 5% or less; or
•	reducing the regional value content required to qualify for origin of a good from the current 50% to 40% immediately, with a further reduction to 30% in 2010.

Ai Group stands by its original position that if significant change is to occur to the ROO, that adoption of a Change in Tariff Classification based ROO methodology, such as the model used in the Australia-Thailand Free Trade Agreement, is the preferred option.

Background

The Productivity Commission’s extensive analysis of the operation of the ROO under CER, made in its interim report of December 2003, highlights some problems that were largely raised by New Zealand companies.

These included inconsistencies with the interpretation and treatment of ROO between Australia and New Zealand, and issues related to the ‘last place of manufacture’ test.

We understand that some measures have already been implemented to address these issues.

Ai Group stands by its earlier position (noted in our 10 October 2003 submission to the Productivity Commission’s study) that the majority of Australian companies are not seeking any change to the ROO under CER.

That said, we do acknowledge that change to the ROO is not only inevitable, but also essential: a workable bilateral treaty must be to the mutual benefit of all parties concerned.

The Productivity Commission Recommendations

The recommendations contained within Interim Recommendation 1 represent relatively minor changes to implement.  They address some immediate issues, before more substantial change is undertaken.

Ai Group accepts the changes suggested in Interim Recommendation 1, as an interim measure.

Interim Recommendation 1
The following changes be made to address some of the day-to-day shortcomings of the current CER ROO.
•	The ‘last place of manufacture’ requirement be replaced with one based on the ‘principal firm’, defined as the firm that performs, or has performed on its behalf, the last process of manufacture in the region.
•	The valuation and coverage of eligible costs in Australia and New Zealand be aligned to achieve a single set of rules implemented according to uniform practices.
•	A standard definition of manufacturing be adopted, based on the Australian and New Zealand Standard Industrial Classification.

The recommendations contained within Interim Recommendation 2, however, are not acceptable to the Ai Group.

Interim Recommendation 2
A ‘waiver be introduced to provide automatic duty free entry to any goods:
•	manufactured within Australia or New Zealand (ie as defined in interim recommendation 1); and
•	for which the difference between the Australian and New Zealand MFN tariff rates is 5 percentage points or less.

1. The waiver option is not a robust system for calculating origin.
The waiver option is fundamentally flawed, as it is not a robust methodology for assessing local content.  This essentially is an option based on not having a system.  It does not take into account all the factors which impact the trade costing equation.  The impact of the Duty-Drawback Schemes in both countries is a good example of how the waiver option fails to accurately calculate local costs.  TCF companies in either country would face unfair competition in their domestic markets, with imports potentially priced lower than domestic goods as they would be eligible for duty-drawback, whereas domestically manufactured and sold goods are not.

2. The definition of manufacture is not sufficient to confer origin.
The key problem with the waiver option, however, is that it stands or falls on the definition of ‘manufacture’, and certainly the basis set out in Recommendation 1 is not adequate.  The ANZSIC was never designed as an origin test, as is evidenced by the fact that it would view the sewing of buttons on a suit enough to satisfy the definition of manufacture and therefore the origin test.

3. The shipping costs outweighing the attractiveness of trans-shipment is a dangerous general assumption.
The assumption that trans-shipment would not be attractive when the difference in MFN tariff rates is 5 percentage points or less, is another questionable factor in the waiver option.  Averages, by their very nature, do not take account of the highest (or lowest) expression of an equation.  What about the goods that are less expensive to ship than 5 percent of the FOB value of the goods?  Is trans-shipment in those cases more likely? Indeed, why was 5 percentage points difference in MFN seen as the cut off point?

Clearly, the reason why a waiver rule is rare among the 262 existing Preferential Trade Agreements (those notified to the WTO), and when used is confined to a highly limited range of products, is because this is not a reliable method of establishing local content.

Ai Group does not support Interim Recommendation 3 either.

Interim Recommendation 3
The regional value content threshold under CER be reduced from 50 per cent to 40 per cent immediately, with a further reduction to 30 per cent in 2010.

The problem with ‘lowering the bar’ is that there will always be companies in the margins that do not find the ROO work for them.  Further, as acknowledged by the Productivity Commission in its interim report, reducing the threshold does not provide a long-term solution to any of the cited disadvantages of the current model.  We do not see the lowering of the threshold as an objective or fair means of satisfying companies that a true and fair level of local content has been achieved.  Further, our research shows that Australian industry is strongly opposed to lowering the threshold.

The Ai Group Recommendation

In place of both the Interim Recommendation 2 and 3, Ai Group recommends that a CTC based methodology be used, along the lines of the Australia-Thailand FTA.  In other words, the ROO contained in Annex 3A of the Singapore - United States free-trade agreement with some important modifications.  

The rationale for using Annex 3A is that it has been tested in several FTAs over the last ten years.  An important overarching rationale for revisiting the CER model is the potential to achieve some level of harmonization between the various trade agreements that Australia has or will be party to.  Harmonisation will simplify the increasingly complex world of trade rules in which Australian companies must operate.

Annex 3A is based on changes in tariff classification (CTC), supplemented in some cases by a Regional Value Content (RVC) based mainly on the build-down method (FOB-based valuation), but in some cases on the build-up method or defined processing requirements.

The key modifications to Annex 3A in the Australia-Thailand version are:
•	altering the ROOs to be applied to textiles and clothing and in particular the removal of the yarn/fibre forward rules;
•	build-down method only used for RVC calculations; and
•	RVC percentages to be capped at 55% (equivalent to 50% ex-factory).

Ai Group recommends the ROO be changed to a CTC-based model.

Ai Group is disappointed that our recommendation for a CTC based ROO model was so quickly discarded in the Productivity Commission analysis.  We found most of the rationale put forward by the Productivity Commission on the topic to be misleading.  The Productivity Commission lists the following disadvantages of CTC rules, with which we disagree:

•	“Harmonized Tariff System (HS) is not designed for origin conferral purposes and is slow to change”
Whilst this statement is on the face of it, true, we know of no classification system that was designed for origin conferral purposes, or indeed, any which offer a better solution.  There is no perfect solution, and therefore relying on the standard classification accepted and used in all countries (for Customs assessment purposes) is a logical extension.

•	“Would result in inconsistent origin determination across sectors”
This fact that origin determination is inconsistent across sectors is one of the assets of CTC based determination.  This flexibility allows the ROO to cater to the particular process of manufacture of any given product: change at a six-digit level may represent significant transformation for some products, and almost none for others.  Any given CTC test is able to appropriately reflect the specific manufacturing processes unique to any given product.

•	“Significant transition costs”
Where products only require a CTC test, the transition costs are negligible.  One of the key advantages of CTC based tests are that the only information a company (or Customs for that matter) need to keep are the HS codes of the inputs and the final product.  This is a significant improvement on the documentation required to prove legitimate calculations of factory costs.

•	“Significant ongoing compliance and administration costs”
As per the previous bullet point, compliance and administration costs are comparatively insignificant under CTC based ROO.

•	“In practice, usually necessary to combine CTC rule with either a RVC rule or a technical test, in which case:
o	Limitations of secondary criteria would apply
o	Product specific rules are used
o	Especially open to industry protection measures
o	Added complexities and compliance costs.”

Transition costs, ongoing compliance and administration costs are a factor to consider when an RVC (Regional Value Content) test is required.  However, and this is a key point, RVC tests do NOT usually apply, as stated in the Productivity Commission report.

RVC tests only apply to around 15% of tariff lines, where substantial transformation cannot be clearly demonstrated through a change in tariff classification alone.

While the use of RVC tests can theoretically mean the ROO are open to industry protection measures, this is not to say that Australia or New Zealand would permit such manipulation.  We would recommend that RVC percentages were equivalent to the 50% ex-factory level.

With regard to added complexities and compliance costs, we acknowledge that this would be the case for the small number of items that do involve an RVC test.  However, these RVC tests are no more complicated or costly to comply with than the current 50% ex-factory RVC test which has been in place for the last 20 years with New Zealand.

Ai Group recommends that the Productivity Commission re-examine the benefits of moving to a Change in Tariff Classification based ROO methodology, such as the model used in the Australia-Thailand Free Trade Agreement.