Net result of proposed rule on 'substantial transformation' unclear

A rule proposed by the Homeland Security Department's Bureau of Customs and Border Protection would require federal government contractors to revisit their Trade Agreements Act (TAA) certifications to ensure they are selling compliant supplies. The rule would amend Customs Bureau regulations that establish a uniform method ? commonly called the tariff shift test ? for determining the country of origin of imported merchandise. Under that method, the Customs Bureau essentially asks whether an imported good has been processed sufficiently within the given country to change its tariff classification. If the answer is yes, the good is deemed "substantially transformed" and a product of that country.The Customs Bureau determines origin for many purposes, including admissibility into the United States, eligibility for preferential trade programs, and marking requirements. Depending on the determination, Customs typically applies either the tariff shift or a case-by-case, fact-sensitive substantial transformation test, which often involves inherently subjective judgments. However, under the proposed regulation, the tariff shift and related rules, which are widely viewed as the more objective approach, will apply across the board to all of Customs' country-of-origin determinations.Why does this matter to government contractors? It's important because the Customs Bureau has regulatory authority to issue binding country-of-origin determinations and advisory opinions relating to federal procurements. The Customs Bureau currently applies the more subjective substantial transformation test. However, under the new rule, the tariff shift would govern. And, while the result often would be more predictable, it might not always be the same. Also, where tariff-shifting cannot squarely be applied to a good, the related rules also involve subjective determinations.Through TAA certifications, government contractors attest that all offered end products are products of the U.S. or certain designated countries. For certification of end products containing materials from non-designated countries (such as China), contractors must use the more subjective analysis to determine whether the supply is substantially transformed by manufacturing processes in the U.S. or in a designated country.Because the proposed rule explicitly adopts the tariff shift for Customs Bureau's procurement determinations, it is clear that a challenge brought at Customs Bureau (or a request for a Customs Bureau opinion as to one's own supplies) would be analyzed under that test. However, it is not clear, at least at this juncture, whether other tribunals would necessarily follow the new rule.For instance, the Government Accountability Office and the Court of Federal Claims have addressed TAA compliance in bid protests. The court has also addressed TAA compliance in claims litigation, where the government sought a refund for non-compliant supplies. TAA compliance can also arise in Federal district courts in False Claims Act cases or if the Justice Department initiates action on an inaccurate certification.While government contracts tribunals can ? and often do ? look to the Customs Bureau for guidance, it is unclear whether they must ? or will ? adopt the tariff shift as the governing test when determining origin or assessing the reasonableness of a contracting agency's determination. Following precedent from various courts, government contract tribunals historically have applied the more subjective test.In summary, the proposed rule is intended to create greater predictability in resolving country-of-origin issues. That should strengthen contractors' confidence in their certifications and reduce the guesswork in this complicated area of law. And while this might hold true in the Customs Bureau context, it is unclear - without further regulatory guidance - whether the same result would be achieved for procurement purposes.Due to the significant civil, criminal and administrative penalties that can result from non-compliance with the TAA, best practices dictate that contractors analyze their supplies under both tests until the issue is resolved when the rule becomes effective.