Understanding and Coping with the U.S.-Mexico-Canada Agreement: USMCA Updates NAFTA Rules of Origin for Motor Vehicles and Auto Parts

On September 30, 2018, the United States, Mexico and Canada announced that they have reached an agreement on a “new, modernized trade agreement for the 21st Century” (USTR, 09/30/2018). Going by the new name of the US-Mexico-Canada Agreement (USMCA), it will entirely replace the North American Free Trade Agreement (NAFTA).

This new FTA – characterized by President Trump as the “most important trade deal that [the US] has ever made, by far” – is a mix of modernization and updating of the 24-year-old NAFTA and new substantive provisions that will impact greatly how multinational companies throughout North America run their manufacturing operations, manage their supply chains, and sell products throughout the North American region.

Among the most important changes for the North American automotive industry are the new rules regarding motor vehicles and auto parts. Updating these rules was a key objective of the U.S. negotiators, making it no surprise that there are significant changes in this area that will sharply impact companies that rely on cross-border North American trade as part of their automotive supply chain.

If your company is involved under any capacity in the automotive business in North America, it is essential that you understand the new rules. From the tracking and recordkeeping provisions (which became even more burdensome), to the new regional content rules, to special wage requirements, there are myriad new requirements that North American automotive companies will need to master in a hurry if they are going to continue manufacturing and doing business in the region. Further, with the USMCA imposing a significant number of burdensome tracking and recordkeeping new provisions (we have yet to find the “modernization” side to these requirements), there are plenty of opportunities for companies that fail to implement the rules appropriately to get involved in costly Customs audits and to pay significant penalties for failing to justify claims of originating content.

To help in the task of jump-starting USMCA compliance, we have summarized USMCA´s very detailed provisions for motor vehicles and for auto parts. So make yourself comfortable as we give you a quick tour of the USMCA and your obligations under the new free trade rules. Your obligation to begin to comply is just around the corner.

Please note that the USMCA is a very detailed agreement. The FTA contains many more details than are described herein and, depending on your circumstances, these details may be quite important. Further, full compliance encompasses specific situations that are not addressed herein. If you have any questions, please feel free to contact the authors.

Motor Vehicles

1. Regional Value Content (RVC) for Passenger Vehicles and Light Trucks.

A key change is in the calculation of the regional content that is required to achieve full duty savings when sending goods across the North American borders. Regional Value Content (RVC) requirement for passenger vehicle and light trucks are calculated under what is known as the net cost method, with the amount of qualifying regional content needed to achieve duty-free entry into another USMCA partner increasing from the NAFTA level of 62.5% to 66% (beginning January 1, 2020), then 69% (beginning January 1, 2021), then 72% (beginning January 1, 2022), and finally ending up at 75% (beginning January 1, 2023). Although these dates can be moved back if USMCA comes into force at a later-than-anticipated time, due to the presence of a “whichever is later” rule, the progression of qualifying content will run in the same order and using the same chronology.

Coping with these escalating regional content requirements will require that manufacturers of these passenger vehicles carefully track their regional content, including the amount of value added by their suppliers. It is anticipated that U.S. Customs, in particular, will be aggressive in enforcing these escalating requirements, including through targeted inquiries and Customs audits.

2. RVC for Heavy Trucks.

The RVC requirement for heavy trucks under the net cost method will increase from 60% (beginning January 1, 2020) (the same percentage as in the current NAFTA), to 64% (beginning January 1, 2024), and then ending at 70% (beginning January 1, 2027) (remember the “whichever is later” rule, as described above, compared to an initiation in 2020, and then 4 and 7 years thereafter). As is true with the passenger vehicle rules, multinational automotive companies will need to manage their supply chains and manufacturing operations to strictly adhere to these new requirements.

3. Averaging in RVC Calculation for Passenger Vehicles, Light Trucks and Heavy Trucks.

For purposes of calculating RVC in a fiscal year, quarter or month, the RVC calculation may be averaged per model line or class of motor vehicle. Other quite detailed requirements will impact how the calculations will be applied in particular circumstances. Companies that are seeking USMCA-exempt status based on regional content will need to carefully parse the rules to determine how they apply in their own particular circumstances.

4. Originating Steel and Aluminum Purchases of at Least 70% for Passenger Vehicles, Light Trucks and Heavy Trucks.

In addition to product-specific Rules of Origin, a passenger vehicle, light truck, or heavy truck will be originating only if, during the prior year, at least 70% of the vehicle producer´s purchases of steel and aluminum are originating as well. This requirement applies to the vehicle producer´s purchases throughout North America only if the producer has more than one location in a Country where steel and aluminum is purchased; in turn, purchases of steel and aluminum include all of the following forms: direct purchases, purchases through service centers, and purchases contracted through a supplier.

5. Labor Value Content (LVC) Requirement for a Passenger Vehicle.

Another big change is the introduction of a Labor Value Content requirement intended to either bring back manufacturing processes into the U.S. (and unintendedly Canada), or raise wages in Mexican facilities, which is something that was not required in NAFTA. The USMCA Labor Value Content requirement for a passenger vehicle is met when the following percentages are accounted for with “high wages” of $16 USD an hour or above in: (i) material and manufacturing expenditures, including transportation costs; in (ii) technology; and (iii) assembly expenditures: 30% (beginning January 1, 2020); then 33% (beginning January 1, 2021); then 36% (beginning January 1, 2022); and finally 40% (beginning January 1, 2023) (remember the “whichever is later” rule, above, initiating in 2020, and then 1, 2 and 3 years thereafter).

High wages for material and manufacturing expenditures, including transportation costs, should account progressively for 15% (beginning January 1, 2020) (out of 30% needed as per prior paragraph); then 18% beginning January 1, 2021 (out of 33%); then 21% (beginning January 1, 2022) (out of 36%); and finally 25% (beginning January 1, 2023) (out of 40%).

Across those years, high wages for technology, a concept that includes Research & Development (R&D) or Information Technology (IT) expenditures, and engine, transmission, or advanced battery assembly expenditures, even through long-term contracts, may account for up to 10% and 5%, respectively.

6. LVC for Light Trucks and Heavy Trucks.

The USMCA Labor Value Content requirements for light trucks and heavy trucks is met when the following percentages are accounted for with high-wages of $16 USD an hour or above in: (i) material and manufacturing expenditures, including transportation costs; in (ii) technology; and (iii) assembly expenditures: at least 30% beginning immediately after entry into force of USMCA.

High wages for material and manufacturing expenditures, including transportation costs, should account for at least 15% during the entire life of this requirement (out of 30% needed, above); therefore, high wages for technology, a concept that includes wages for R&D or IT, and assembly expenditures, may account for up to 10% and 5%, respectively.

For the period ending January 1, 2027, the LVC for heavy trucks increases beyond 45%; any percentage that exceeds the 30% of high wage requirement in material and manufacturing expenditures may be used to comply with RVC requirements.

7. Averaging in LVC Calculation for Passenger Vehicles, Light Trucks and Heavy Trucks.

For purposes of calculating LVC in a year, the calculation may be averaged per model line, class of motor vehicle, or any other category (several other, detailed conditions apply).

8. Transition Period to Comply with RVC, Averaging, Steel and Aluminum, LVC and Parts Requirements, on a Producer-by-Producer Basis.

Regarding passenger vehicles and light trucks, for a period ending in January 1, 2025 (or 5 years after entry into force of the USMCA, whichever is later), there may be an alternative staging regime to comply with RVC, Averaging, Steel and Aluminum, LVC and Parts (exclusively Super Core parts in Table A.1 below) requirements, which may benefit up to 10% of the producer´s total North America production during the past 12 months prior to entry into force of the Agreement.

Regarding heavy trucks, for a period ending in January 1, 2027 (or 7 years after entry into force, whichever is later), there may be an alternative staging regime to comply with RVC, Averaging, Steel and Aluminum, LVC and Parts. The aforementioned 10% limit during past 12 months of North American production does not apply to heavy trucks.

The aforementioned staging regimes may be extended or modified by the United States, Mexico and Canada if such actions would result in new investments for vehicle or parts production in North America.

9. RVC for Other Vehicles and Their Parts.

Beginning immediately after entry into force of the USMCA, there is a RVC requirement of 62.5% under the net cost method for the following motor vehicles and their parts: those for the transportation of 10 or more persons. including the driver, with a diesel engine; those with a compression-ignition engine; a three- or four-wheeled motorcycle; a motor home or entertainer coach; or a vehicle solely or principally for off-road use.

Beginning immediately after entry into force of the Agreement, there is a RVC requirement of 60% under the net cost method for the following motor vehicles and their parts: tractors (except road tractors for semi-trailers); dumpers for off-highway use; and motor vehicles for transportation of goods solely or principally for off-road use.

For purposes of calculating RVC in a fiscal year, the calculation may be averaged per model line, or class of motor vehicle.

In addition, for 2 or 5 years after the date Other Vehicle prototype is respectively refitted or produced in a vehicle assembler´s plant, the RVC requirement is 50%.

Whew! We hope that you are taking a deep breath; we know this took an effort to read. Trust us; it will take even more of an effort to implement. Now you need to exhale and learn about the special rules for auto parts.

Auto Parts

1. Replacement Parts as Stand-Alone Items.

We do not consider replacement items to be considered as “parts” to be used in an originating motor vehicle. This reading coincides with the definition of “material” in the USMCA, that is, “a good that is used in the production of another good, and includes a part or an ingredient.”

Therefore, replacement parts are not subject to RVC or LVC requirements, but instead need to comply with the ordinary (that is, non-automotive specific) Chapter 4 Rule of Origin requirements.

2. Table A.1, Super Core Parts for Vehicles and Light Trucks (15 Harmonized Tariff Lines, HTS).

Super Core parts need to comply with the RVC requirements of 66% using the net cost method (or 76% transaction value method if available) beginning January 1, 2020; then 69% net cost (or 79% transaction value if available) beginning January 1, 2021; then 72% net cost (or 82% transaction value if available) beginning January 1, 2022; and finally 75% net cost (or 85% transaction value if available) beginning January 1, 2023. The “whichever is later” rule applies, initiating in 2020, and then 1, 2 and 3 years thereafter.

In addition, the “averaging” provisions in the RVC calculation apply as well to Super Core parts in Table A.1. That is, calculations in RVC in a fiscal year, quarter or month may be averaged per model line or class of motor vehicle. As with the other rules, several other detailed conditions may apply, depending on your particular circumstances.

3. Table A.2, Parts and Components for Passenger Vehicles and Light Trucks (7 Parts and a Number of Corresponding Components).

Parts and components are listed in tandem; that is, for every “part,” there is a list of its corresponding “components.” Each Country will provide additional descriptions and clarifications as needed to facilitate the implementation of Table A.2´s requirements.

The USMCA has provisions to encourage manufacturing of key automotive components within Canada, Mexico, or the United States. A passenger vehicle or light truck can only be originating if the following “parts” are themselves originating (see Column 1 in Table A.2): engine, transmission, body and chassis, axle, suspension system, steering system, and advanced batteries. Components themselves do not need to be originating, though very minute details and requirements are given regarding the relationship between parts and their components.

4. Table B, Principal Parts for Passenger Vehicles and Light Trucks (53 HTS).

Principal parts need to comply with the RVC requirements of 62.5% net cost (or 72.5% transaction value if available) (beginning January 1, 2020); then 65% net cost (or 75% transaction value if available) (beginning January 1, 2021); then 67.5% net cost (or 77.5% transaction value if available) (beginning January 1, 2022); and finally 70% net cost (or 80% transaction value if available) (beginning January 1, 2023). The “whichever is later” rule applies, initiating in 2020, and then 1, 2 and 3 years thereafter.

5. Table C, Complimentary Parts for Passenger Vehicles and Light Trucks (28 HTS).

Complementary parts need to comply with the RVC requirements of 62% net cost (or 72% transaction value if available) (beginning January 1, 2020); then 63% net cost (or 73% transaction value if available) (beginning January 1, 2021); then 64% net cost (or 74% transaction value if available) (beginning January 1, 2022); and finally 65% net cost (or 75% transaction value if available) (beginning January 1, 2023). The “whichever is later” rule applies, initiating in 2020, and then 1, 2 and 3 years thereafter.

6. Table D, Principal Parts for Heavy Trucks (38 HTS).

Principal parts for heavy trucks need to comply with the RVC requirements of 60% net cost (or 70% transaction value if available) (beginning January 1, 2020); then 64% net cost (or 74% transaction value if available) (beginning January 1, 2024); and finally 70% net cost (or 80% transaction value if available) (beginning January 1, 2027). The “whichever is later” rule applies, initiating in 2020, and then 4 and 7 years thereafter.

7. Table E, Complementary Parts for Heavy Trucks (15 HTS).

Complementary parts for heavy trucks need to comply with the RVC requirements of 54% net cost (or 64% transaction value if available) (beginning January 1, 2020); then 57% net cost (or 67% transaction value if available) (beginning January 1, 2024); and finally 60% net cost (or 70% transaction value if available) (beginning January 1, 2027). The “whichever is later” rule applies, initiating in 2020, and then 4 and 7 years thereafter.

8. Table F, List of Tariff Provisions for Other Vehicles (At Least 81 HTS, as There Are Groups That Begin in One HTS and End in Another).

Parts included in Table F that are for use in Other Vehicles (item 9 of Motor Vehicles, summarized in next paragraph), immediately after entry into force of the Agreement, are subject to a 60% RVC requirement under the net cost method. The value of non-originating materials are particularly tracked for goods contained in Table F.

Reference above for Other Vehicles includes the following: for the transportation of 10 or more persons including the driver, with diesel engine; with a compression-ignition engine; a three- or four-wheeled motorcycle; a motor home or entertainer coach; vehicles solely or principally for off-road use; tractors (except road tractors for semi-trailers); dumpers for off-highway use; and motor vehicles for transportation of goods solely or principally for off-road use.

Goods and components or materials in Table F (and G, below) can benefit from averaging provisions over a fiscal year, quarter, or month.

9. Table G. List of Components and Materials for Other Vehicles (2 Components Provided for in 3 HTS, and a Number of Corresponding Materials).

Components listed in Table G that are used as original equipment in the production of Other Vehicles are tracked under special rules, particularly regarding the value of non-originating materials.

The concept of Other Vehicles covers: tractors (except road tractors for semi-trailers); dumpers for off-highway use; motor vehicles for transportation of goods solely or principally for off-road use.

Goods and components or materials in Table G (and F, above) can benefit from averaging provisions over a fiscal year, quarter or month.

As you were able to see (and read), the USMCA rules have changed, and by no means for the simpler. USMCA treatment for Motor Vehicles and Auto Parts requires careful implementation, will be burdensome, and will require significant tracking and recordkeeping. Nonetheless, the potential monetary savings for most companies will make an investment in understanding the rules and compliance with them a cost-effective exercise.

Given the deadline for many of the requirements (potentially as soon as the start of 2020), we recommend tackling the USMCA provisions as early as possible. Implementation often will require engaging your entire supply chain, making an early start essential. Please contact the author if you have any questions.