Canada and Mexico are now the second- and third-largest trading partners of the United States, respectively, and NAFTA as a whole comes in just slightly behind the 15-member European Union in terms of overall world trade.

Benefits

The benefits of NAFTA to American companies are obvious-reduced or duty-free treatment on imported goods and the ability to take advantage of inexpensive Mexican labor for assembly operations. Mexico's proximity to the United States is also conducive to cross-border manufacturing operations, known as maquiladoras. Traditionally, however, maquiladoras have been used for 9802 operations, meaning that only the value of American components was duty-free.

For example, shoes manufactured in Mexico use rubber soles made in the U.S. The shoes don't qualify for NAFTA because they don't meet the rules of origin. Since the value of a finished pair of these shoes is $10 and the value of the rubber soles is $2, the importer would pay MFN duties applicable to an $8 pair of shoes-the $2 soles would be imported free of duty under 9802.

NAFTA is an expansion of 9802, making it possible to import an entire product free of duty even if it contains non-NAFTA components, provided strict guidelines are followed.

Penalties

The three NAFTA countries impose criminal, civil, and administrative penalties for violations of laws and Customs procedures relating to the agreement. Exporters, for example, can be penalized for falsely representing a good as originating on a Certificate of Origin. And importers can be penalized for making false claims for preferential NAFTA treatment on the Customs import documentation. Both importers and exporters may be penalized for failing to retain records for five years. Preferential benefits can also be denied if Customs administration finds that a good does not qualify as originating.

Qualification and Rules of Origin

The NAFTA cost-saving measures are available only with a soundly integrated management system in place. The two main reasons are to ensure that the goods are being granted NAFTA preferential status and to keep the entire transaction compliant with the Customs Modernization Act.

The preferential status is determined by the complex methodology of the Rules of Origin, and if not properly managed can result in a denial of NAFTA eligibility.

Rules of Origin

NAFTA grants maximum benefits to goods that originate in Canada, Mexico, or the United States. Origination is determined by Article 401 of the agreement, which defines "originating" in the following four ways:

1. Goods wholly obtained or produced in the NAFTA region-Wholly obtained or produced refers to minerals extracted, vegetables harvested, live animals, goods harvested from the sea or produced on ships registered to Canada, Mexico, or the United States.

2. Goods produced in the NAFTA region wholly from originating materials-There is a de minimus exception if 7% or less of the final product is non-originating.

3. Goods meeting the Annex 401 origin rules-The Annex 401 rules of origin are referred to as specific rules of origin and are based on a change in tariff classification, a regional value-content requirement or both.

4. Unassembled goods and goods classified with their parts which do not meet the Annex 401 rule of origin (tariff change) but do contain 60% regional value content using the transaction method (50% using the net cost method)-There are only two instances in which this provision may be used. The first is when goods are imported into Canada, Mexico, or the United States in an unassembled or disassembled form, but are classified as assembled goods pursuant to General Rule of Interpretation of the Harmonized System (HS), which is the global classification system used to define most world trade in goods. The second circumstance involves goods produced using materials imported into a NAFTA country that are provided for as parts according to the HS, and those parts are classified in the same subheading or undivided heading as finished goods.

Applying NAFTA

Let's assume that a U.S. company wants to assemble control instruments in Mexico for use in heating systems and then import the instruments to the U.S. The HS classification of these units is 9032.89.6025 and the transaction value is $48. The bill of materials shows the following:

An analysis of the tariff shift rule for HS 9032.89.6025 reads:

A change to subheadings 9032.10 through 9032.89 from any other heading.

A change to subheadings 9032.10 through 9032.89 from subheading 9032.90 whether or not there is also a change from any other heading, provided there is a regional value content of not less than 60% where the transaction value method is used or 50% where the net cost method is used.

In this scenario the three non-originating parts meet the first tariff shift rule since they are derived from a different four-digit heading. Only the thermostat comes from the same heading and, since this component is from Canada, it's originating and therefore not considered.

If the thermostats didn't originate from NAFTA, one would have to move to the Regional Value Content rules, and those are far more complicated. Two different methods may be used, the Transaction Value method or the Net Cost method. Each involves demonstrating to Customs the production costs of the goods and the relationship of the value of NAFTA to non-NAFTA components.

The last critical hurdle for the importer is to comply with the Customs Modernization Act and its extensive recordkeeping requirements. Manufacturers' affidavits and NAFTA certificates of origin must be obtained and submitted upon demand by Customs. Records must be maintained for five years and these are often the subject of Customs audits which, under NAFTA, can even include inspection of an assembler's plant.

Technology and NAFTA

The seamless integration of technology and the NAFTA Rules of Origin allow a company to determine whether goods are eligible for the discounts. And, while there is a tremendous need for this technology, a limited number of companies have the knowledge and experience to provide these necessary services. The following are the requisite functions that make goods eligible for NAFTA benefits:

• System can automatically store and manage receipt of manufacturer certifications, and track and alert expiration of certifications, automating review and re-issuance as necessary.

• Inventory details are stored in a database and used to track the manufacturing company of the product, assembly, improvement value content and country of origin percentages.

• Assembled components can be tracked and used to calculate NAFTA qualifications and maintain an accurate audit trail.

• Solution permits users to generate NAFTA certificates and/or advise the company of qualification of goods to actual exporter.

• Populates the NAFTA documents with the shipment data to take full advantage of preferential duty treatment. Required forms should be available and retrievable on demand for NAFTA qualification. Supplier requests, NAFTA filings and inventory details should be stored to maintain an accurate and easily accessible audit trail.

• Information is obtainable on all qualifications without intense effort and time, including inventory tracking, supplier information requests and other relative information.

NAFTA presents an outstanding opportunity for U.S. businesses But it's only the savvy importer with an effective NAFTA management system in place that stands to benefit fully from the agreement. A company without a robust management system for facilitating global trade will be subject to Customs audits, denial of NAFTA status, and possibly charged with fines and/or assigned penalties.

International companies have a broader range of technology implementations to consider compared to domestic companies. Crossing borders changes the entire way companies have to perform everyday business functions. NAFTA was created to help neighboring countries successfully trade and improve business effectiveness. The Agreement is in place, but it is the responsibility of companies to maximize the benefits of NAFTA.