Prepare to bid adieu to 'substantial transformation'

Buylines | Policies, strategies and trends to watch

Manufacturers of technology must now evaluate a newly proposed system for determining the country of origin of manufactured items because the old "substantial-transformation" test will likely give way to a "tariff-shift" test. Technology manufacturers serving the federal market will want to determine whether the new tariff shift country-of-origin test will affect current production and distribution procedures.

On July 25, the Customs and Border Protection agency began the process of changing the way country of origin is determined in an effort to make those determinations easier and more transparent. Customs has always been the arbiter of the substantial transformation test ? the location wherein disparate items of commerce are combined to form an article of commerce with a name, character or use distinct from any of its constituent parts. To determine origin without a shadow of a doubt requires Customs to make a case-by-case ruling for each item. Few companies actually go through this two-year process. Most take their chances by relying on what they believe is a reasonable interpretation. If Customs has its way, this subjective, case-by-case approach will become history.

The proposed system defines country of origin as the place at which the final tariff shift occurs. This system is more formulaic and codified and should allow manufacturers to make their own determinations by following the country of origin North American Free Trade Agreement Marking Rules at 19 CFR 102. This process is based on the Harmonized Tariff Schedule of the United States (HTSUS), a hierarchical coding scheme whereby everything that is bought and sold in the world is categorized by the World Customs Organization and carries a specific code. For instance, products related to information technology fall within chapters 84 and 85, automatic data processing machines are at heading 8471 and integrated circuits are at 8542. More digits are added to indicate each increasing level of specificity. Thus, a notebook computer is subheading 8471.30, and a hard disk drive is 8471.70.

A manufacturer will seek to show that a tariff shift occurred in the country of origin by identifying the HTSUS codes of each component and will also show that more than "minor" processing is involved to create a new product with a code different than any of the components. This sounds straightforward until you actually get into the coding system, the labels of which seem absolutely archaic relative to current technology. Combine that with the marking rules and a number of exceptions, and this gets complex.

Chances are your corporate import/export tariffs counsel is well aware of these proposed changes; but in my experience, it is the rare corporate management team that thinks about how changes in trade policy affect its public-sector channels of distribution. Sadly, the federal government sales team is often apprised of manufacturing decisions long after they have been implemented, putting the team's government customers and contractor intermediaries in the awkward position of unknowingly running afoul of the Trade Agreements Act (TAA) when items marked with a country of origin label from a prohibited country show up on the loading dock.

This means that the manufacturer needs to look at its government production facilities and make sure the existing processes meet the tariff shift test for the desired country of origin. Although some in industry hold out hope that somehow this new regime won't come to pass, I don't think anyone should plan on that happening.

I do see precedent for grandfathered provisions and exceptions. So if your company finds that it will need to make adjustments to remain TAA compliant under this new approach to country-of-origin determination, it should be helping to write comments emphasizing the costs to change, risks to the government supply chain, and proposed exceptions to the tariff shift scheme for your category of products.

Feel free to contact me about this as I chair the TAA Task Force within the Information Technology Association of America's Federal Procurement Policy Committee and I will make sure your examples are forwarded by the Oct. 23 comment deadline in a way that will inform the rule-making process.

Steve Charles (steve_charles@immixgroup.com) is co-founder of the consulting firm immixGroup Inc. For a related perspective on the topic, see the Sept. 11 Infotech and the Law column.

About the Author

For the past two decades Mr. Charles has helped hundreds of technology manufacturers succeed in the government marketplace. His breadth and depth of expertise on every dimension of the government technology ecosystem provide technology manufacturers with a strategy and clear focus for the greatest success. Mr. Charles is adept at mapping technology product lifecycles and revenue models with appropriate channel and contract vehicle strategies in light of current procurement law, regulations and policy. He receives glowing reviews from the training workshops he facilitates to help sales teams understand the sales tactics needed to address each step in the government acquisition process. Mr. Charles is actively involved in government-industry associations including TechAmerica, ACT-IAC, Coalition for Government Procurement, and the National Contract Management Association. He meets regularly with leaders in government and industry to increase understanding and positive action. Mr. Charles co-authored The Inside Guide to the Federal IT Market, a how-to book for technology companies selling to the government. He is regular contributor to Washington Technology.

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