CHAPTER FIVE CUSTOMS PROCEDURES

Customs Procedures usually consist of Transit, Warehousing, and Clearance of both Imports and Exports. Accordingly, this Chapter deals with these basic concepts. 5.1. Imports There are a number of regimes that may apply to goods when they are imported. The goods may be: Cleared for home use with any taxes being paid; Moved from the import area under bond in transit to another Customs office elsewhere in the country. Often this process is used to move the goods through the country to a land border where they pass through border controls and enter another Customs administrations responsibility; Transshipped from the import conveyance (aircraft, vessel or vehicle) at the import Customs control area to another conveyance subject to Customs control within the same area; The goods may be moved to a duty free zone; or The goods may be warehoused and held under bond until the consignee wishes to clear the goods or re-export them.
1

a. Clearance for Home Use Goods arriving at a border control point come under the control of Customs. This, depending upon a countrys legislation, involves Customs in a range of activities which have the objective of keeping control of imported goods and goods intended for export (and their means of conveyance) until they are given clearance by Customs. To clear a consignment through Customs, the owner or the broker is normally required to lodge an import or home use declaration and to tender the Customs duty and other taxes (such as Excise and VAT) that may be due. Certain obligations are placed on the declarant before he obtains clearance. Assuming for the moment that the declaration is paper based (rather than an electronically lodged declaration), the document must be supported by an invoice, often a copy of the bill of lading or air waybill and other documents such as an import license, certificate of origin, etc. Again, depending upon the legislation, electronic lodgment may be supported by electronic invoices etc., or these may only be required to be produced when requested by Customs. The Revised Kyoto Conventions general provisions relating to the payment or deferment of duties are included in the Chapter 4 of the General Annex. In the process of approving the release of goods from Customs control, officers generally undertake the following:
2

 Registration of the Goods Declaration; Verification of declaration and supporting documents; Examination of the goods, if required; Enforcement of other statutory provisions relating to the control of the imported goods (such as identifying prohibited goods or ensuring that restricted goods have the appropriate permits). In some cases they may verify that other legislative requirements administered by other Government agencies are met (e.g. veterinary, health, phytosanitary, etc.); Assessment and collection of import duties and taxes; Release of the consignment; Ensuring the import data on the declaration is recorded (usually electronically) for trade statistical purposes and transferal of that data to the Governments statistics department. This process can be fast and efficient or, if the procedures are bureaucratic and complicated, the process may be seen as a barrier to trade and as imposing costs which adversely impact upon the
3

countrys economy. The efficiency of the clearance for home use procedure and the ease with which goods can be cleared is often the barometer by which a commercial enterprise determines where it will do business. The introduction of appropriate facilitative and forwardlooking measures by Customs which permit the speedy clearance of goods for home use, yet accommodate barriers to illicit goods and illegitimate trade, are necessary features of a modern and productive economy (WCO 1999, Specific Annex B). The World Bank report entitled Cambodia at the Crossroads: Strengthening Accountability to Reduce Poverty, issued in December 2004, analyses the trade and investment climate in that country and identifies barriers to trade and investment. In relation to the inspection and clearance of goods, the report states: Customs clearance by itself imposes substantial delays and great variation, and hence, unpredictability. On average, firms report that imports take 6.5 days to clear Customs, while exports take 4.5 days. However, this timing is variable, and firms report that in the last year they have had to wait an average of over 11 days for at least one shipment, and 16 days to clear an export shipment. Total costs of clearing goods also vary" (World Bank, 2004: 96). Modern, facilitative approaches may include: Standardization and simplification of documentation;

 Utilization of release procedures for low value consignments so formal declarations are not required; Use of pre-arrival information to risk assess consignments to allow quick release of low risk consignments; Allowing the release of goods solely on the information contained in the bill of lading or airway bill.

Recommended Practice 2 in Specific Annex B states: National legislation should provide that goods may be declared in an alternative manner to the standard Goods declaration on the condition that it provides the necessary particulars relating to the goods to be cleared for home use. As a trade facilitation measure, many Customs Administrations allow certain goods to be declared for home consumption using an alternative method instead of the official Goods Declaration. This may be done simply by endorsing the airway bill that the low value consignment does not require examination and is released from Customs control. Alternatively a simplified, substitute form for the declaration may be used to calculate the duty and taxes where the consignment value is under the prescribed threshold. This often applies to passengers
5

personal effects and to certain consignments at an international mail facility - this allows for facilitated clearance without the normal import documentation. This procedure therefore differs from the provisions of Transitional Standard 3.32 of the General Annex which is available only to authorized traders. Customs legislation usually specifies the types of goods that can be cleared in this manner and normally covers goods in large volumes and of low risk or goods that are unconditionally free of duties and taxes. This may include for example, newspapers, journals and periodicals. b. Relief From Import Duties and Taxes Most Customs Administrations provide relief from import duties and taxes on certain goods cleared for home use, irrespective of the tariff classification and tax liability, provided that they are imported under specified conditions. Relief may be granted on philanthropic or humanitarian grounds when disasters occur. It may also be intended to encourage education, science and culture, or to encourage international relations, or be introduced simply for administrative convenience to avoid expenditure that would be out of proportion to the amounts collected. Lets briefly look at the provisions of the Revised Kyoto Convention: Standard 2

National legislation shall enumerate the cases in which relief from import duties and taxes is granted. As the provisions that allow relief differ in each Customs Administration, the Convention requires that each countrys Customs legislation clearly indicates what goods are given relief and whether conditions apply in each case. This requirement ensures that the provisions are transparent and accessible to all interested parties. Standard 3 Relief from import duties and taxes shall not be limited to goods imported directly from abroad but shall also be granted for goods already placed under another Customs procedure. This standard recognizes that some goods may be held under bond in a Customs Warehouse this provision ensures that these goods may be granted relief as long as any prescribed conditions are met. Recommended Practice 4 Relief from import duties and taxes should be granted without regard to the country of origin of the goods or the country from which they arrived, except where an international instrument provides for reciprocity. Certain international instruments provide for relief on a reciprocal basis. As one example, there are a number of reciprocity clauses covering certain materials and equipment contained in the International Convention on International Civil Aviation (Chicago
7

Convention). The reciprocity provisions based on these clauses are normally established in the respective bilateral air agreements between contracting states. Such reciprocity clauses are further explained in the International Civil Aviation Organization (ICAO) Facilitation Manual and the conditions established by them are contained in national legislation. More specifically, administrations may agree to provide for mutual relief from duties and taxes on ground equipment such as aircraft servicing equipment, security equipment, instructional material and training aids imported into the territory of a Contracting State to the Chicago Convention, by or on behalf of an operator of another Contracting State for its own use within the limits of an international airport (WCO 1999, Specific Annex B guidelines). Standard 5 National legislation shall enumerate the cases in which prior authorization is required for relief from import duties and taxes and specify the authorities empowered to grant such authorization. Such cases shall be as few as possible. A requirement to obtain prior approval may delay Customs Clearances. The guidelines to the Convention recommend that cases in which prior authority is required are limited. Recommended Practice 6 Contracting Parties should consider granting relief from import duties and taxes for goods specified in international instruments
8

under the conditions laid down therein, and also give careful consideration to the possibility of acceding to those international instruments. This addresses the fact that many goods are covered in international agreements. Some of these international instruments are old and there is presently no real consistency in the harmonization of the conditions for granting relief from duties and taxes among the contracting parties to these instruments. New international instruments covering relief from duties and taxes have been established. These are intended to eventually supersede and modernize the earlier agreements. Recommended Practice 6 seeks to encourage Members to accede to these new instruments and to adopt facilitative measures to harmonize the conditions for granting relief from duties and taxes. Relevant international instruments referred to above include: Goods referred to in the Annexes to the UNESCO Agreement on the Importation of educational, scientific and cultural materials (New York, 22 November 1950) and to the Protocol thereto (Nairobi, 26 November 1976) as well as in the UNESCO Agreement for facilitating the international circulation of visual and auditory materials of an educational and cultural character (Beirut, 1948). Annex B.5 of the Istanbul Convention is the updated international instrument covering goods imported for educational, scientific or cultural purposes;
9

 Equipment or material referred to in Recommended Practices 4.39 and 4.41 of Annex 9 (7th Edition) to the Convention on International Civil Aviation (Chicago Convention, Chicago, 7 December 1944); Tourist publicity documents and material referred to in the Additional Protocol to the Convention concerning Customs facilities for touring, relating to the importation of tourist publicity documents and material (New York, 4 June 1954). Annex B.7 of the Istanbul Convention, concerning tourist publicity material, is intended to update, modernize and eventually replace this Additional Protocol; Products referred to in Articles 6 and 7 of the Customs Convention concerning Facilities for the importation of goods for display or use at exhibitions, fairs, meetings or similar events (Brussels, 8 June 1961); Goods imported under diplomatic or consular privileges as referred to in the Vienna Conventions on Diplomatic Relations (18 April 1961) and Consular Relations (24 April 1963) (WCO 1999, Specific Annex B guidelines, p7). Additional information on the above can be found in Appendix 1 to the Specific Annex B guidelines.
10

Recommended Practice 7 Relief from import duties and taxes and from economic prohibitions and restrictions should be granted in respect of the following goods under the conditions specified, and provided that any other requirements set out in national legislation for such relief are complied with: a. Therapeutic substances of human origin, blood grouping and tissue typing reagents, where they are consigned to institutions or laboratories approved by the competent authorities; b. Samples of no commercial value which are regarded by the Customs to be of negligible value and which are to be used only for soliciting orders for goods of the kind they represent; c. Removable articles other than industrial, commercial or agricultural plant or equipment, intended for the personal and professional use of a person or members of his family which are brought into the country with that person or separately for the purpose of removal of his residence to the country; d. Effects inherited by a person who, at the time of the death of the deceased, has his principal residence in the country of importation and provided that such personal effects were for the personal use of the deceased;

11

e. Personal gifts, excluding alcohol, alcoholic beverages and tobacco goods, not exceeding a total value to be specified in national legislation on the basis of retail value; f. Goods such as foodstuffs, medicaments, clothing and blankets sent as gifts to an approved charitable or philanthropic organization for distribution free of charge to needy persons by the organization or under its control; g. Awards to persons resident in the country of importation subject to the production of any supporting documents required by the Customs; h. Materials for the construction, upkeep or ornamentation of military cemeteries; coffins, funerary urns and ornamental funerary articles imported by organizations approved by the competent authorities; i. Documents, forms, publications, reports and other articles of no commercial value specified in national legislation; j. Religious objects used for worship; and k. Products imported for testing, provided that the quantities imported do not exceed those strictly necessary for testing, and that the products are used up during testing or that remaining

12

products are re-exported or rendered commercially valueless under Customs control.

5.2.

Exportation Compared with the different regimes that apply to the importation of goods, the Revised Kyoto Convention pays only limited attention to exports. This is not altogether surprising, as once goods leave the Customs territory; they generally cease to be of interest to Customs unless they are expected to be re-imported under provisions relating to outwards processing. Indeed, in many countries, Customs Authorities have been keen to provide maximum facilitation for exports so as to assist with trade as much as possible. Nevertheless, there are reasons why Customs cannot ignore exports: There are international conventions which prohibit the export of certain proscribed goods; There are some countries which impose duties on certain exports;

13

 Many countries exempt exports from goods and services taxes, and so accurate records of exports are necessary to reduce the risk of fraud; Balance of payments data depend on accurate export statistics; Some countries require pre-shipment inspections in the country of origin of the goods to assist with verification of origin and value; and To reduce terrorist risks, the US Governments Container Security Initiative requires the transmission of data to the US on containerized goods 24 hours before they leave the port of departure for shipment to the USA. There is now greater pressure on Customs to exercise effective controls over exports as well as over imports. This pressure has developed particularly in the last few years and after the conclusion of the Revised Kyoto Convention. 5.2.1. Specific Annex C of the Revised Kyoto Convention Chapter 1 of Specific Annex C is entitled Outright Exportation. It therefore deals with circumstances where the goods concerned are not expected to return to the Customs Territory (unlike goods that are departing for outwards processing). Annex C starts from the presumption that goods being exported will be brought under export
14

procedures through the lodgment of an export declaration. The general provisions relating to declarants in the General Annex (Standards 3.6 and 3.7) and to declarations (Standards 3.11 and 3.12 of the General Annex) also apply to export declarations. The provisions of Annex C are very straightforward. Standard 1 is the basic provision saying that outright exportation shall be governed by this Chapter. Recommended Practice 2 provides that goods may be declared in a manner alternative to the standard Goods declaration, on the condition that it provides the necessary particulars relating to the goods to be cleared. This is a facilitative measure which is intended to be available to all traders (not just authorized traders). It is intended to allow Customs to use documents such as commercial invoices or manifests to provide the information required to allow the goods to depart. Standard 3 provides that the Customs shall not require evidence of the arrival of the goods abroad, as a matter of course. This provision recognizes that once goods have left the Customs territory they are no longer of interest to Customs. 5.2.2. Export Control Export control laws provide for two main functions: Authority and powers to interfere with the activities of an exporter, as well as the establishing of the rights and responsibilities of exporters; and

15

 Codification of what is a legitimate export and what is not. The former function is usually implemented through primary legislation such as an Act of Parliament, whereas the latter is usually contained in subsidiary legislation such as Regulations because there may be a need to amend lists on a regular basis. One of the notable areas of export control is that related to the Wassenaar Arrangement on Export Controls for Conventional Arms and Dual-Use Goods and Technologies, which was designed to prevent destabilizing accumulation of arms and dual-use goods and technologies. The Arrangement encourages transparency, consultation and, where appropriate, national policies of export restraint on those items found on the relevant lists. Members maintain export controls on the Wassenaar Munitions and Dual-Use Lists which are regularly reviewed by experts of the Participating States and revised as needed. However, the decision to transfer or deny any controlled item remains the responsibility of individual member states. Control lists require a balance between comprehensiveness and effectiveness. Certain items have been designed, developed and produced specifically for military purposes or adapted for military purposes. Control lists need to include all such items. Other items that may be used for military purposes were developed for civil applications or with both civil and military end-uses in mind.

16

A comprehensive list will include all items that undermine the purpose of the export control policy. However, if a list captured a high percentage of civil application goods, it would not only impede a significant volume of trade, but could put an onerous burden on decision-making. A control list may specify performance capabilities (i.e. what a product enables the user to do) or technical specifications (i.e. a description of the product). There will usually be a requirement of an export license coupled with compliance and enforcement strategies. Summary Imports/Exports Goods entering and departing a country may be intended for many different uses. It is Customs role to determine what those uses are and to deal with the goods accordingly. As much as possible, Kyoto seeks to make these procedures simple and transparent and uniform throughout the world. This balance between facilitation and effective maintenance of Customs control, difficult enough at the best of times, has been made both more difficult and more crucial as the world deals with the threat of international terrorism. At the same time, the WTO has included Customs facilitation as an issue in the Doha Round of negotiations. The challenge for Customs services everywhere will be to make Kyoto an effective basis for the clearance of goods in ways that will satisfy the growing demand for supply chain security and rapid cargo clearance.

17

5.3.

Transit Customs control involves a range of activities which have the objective of keeping control of imported, and exported, goods until they are given clearance by the Customs. Customs Transit & Transshipment are the titles given to the control mechanisms over goods either passing through a territory or being moved around a territory while remaining under Customs control.

These control mechanisms are necessary because international consignments are not always destined for consumption in the territory where the goods are first imported. There are times when the goods are consigned to the markets of another territory but need to be transported through neighboring territories to reach their destination. This journey through the Customs control of one country is known as Transshipment and there are international agreements which relate to the practice. Similarly, goods might be imported at a place (port or airport) in a territory but are required at another place located in that territory. The movement of the goods under Customs control in these cases is known as domestic transit. However, where the goods are transferred from an importing vessel to an exporting vessel in the same Customs area, the movement of the goods is known as Transshipment.

18

Transit is defined in the Specific Annex E, Chapter 1 Guidelines of the Revised Kyoto Convention as follows: Customs Transit means the Customs procedure under which goods are transported under Customs control from one Customs office to another.

Note: Customs Office is defined in Chapter 2 of the General Annex of the Revised Kyoto Convention as the Customs administrative unit competent for the performance of Customs formalities, and the premises or other areas approved for that purpose by the competent authorities. In practical terms, the Customs operation at an airport in a territory is one Customs office and the Customs operation at a sea port in the same Customs territory is another Customs office. Transshipment is defined in the Specific Annex E, Chapter 2 Guidelines of the Revised Kyoto Convention as follows: Transshipment: means the Customs procedure under which goods are transferred under Customs control from the importing means of transport to the exporting means of transport within the area of one Customs office which is the office of both importation and exportation.
19

Goods subject to national prohibitions and restrictions may be authorized under transshipment. This permission does not, however, apply to goods which are concealed as smuggled goods. Where prohibited and restricted goods are authorized for transshipment, the Customs of the through territory (where the prohibition or restriction exists) may need additional safeguard requirements, such as evidence of ultimate arrival or, indeed, Customs escort. Goods carried under transit or transshipment procedures, both international and domestic, are in a form of limbo between geographical points and if that state is broken en route, the goods will be subject to another Customs procedure. This could be, for example, entry for home use or for warehousing. International Influences on Customs Transit There are two Conventions which are closely related to the administration of Transit. They are: The Customs Convention on the International Transport of Goods under cover of TIR carnets (the TIR Convention) which was completed in Geneva on 14 November 1975; and The Customs Convention on the ATA carnet for the temporary Admission of Goods (ATA Convention) which was completed in Brussels on 6 December 1961.

20

The TIR Convention is directly associated with Customs transit, while the ATA Convention has linkages which also need to be taken into account. 5.3.1. The TIR Convention Depending upon your country of residence, you may or may not be familiar with the sight of large trucks with the badge TIR on the tail, lumbering along the motorways. You may in fact have wondered what TIR stood for. This Convention has a fairly long history. It was formulated under the authority of the United Nations Economic Commission for Europe (UNECE). It has its origins in two earlier UNECE Conventions (1949) one was on commercial vehicles and the other on goods transported by road but these Conventions served only a few European countries. Under the provisions of these two texts, road vehicles could, however, be imported temporarily under cover of the Customs carnet de passages (the forerunner of the ATA Convention). At this time, international transport of freight was booming, and a way had to be found for the Customs to seal the goods so that the Customs formalities could take place at the destination rather than at the originating border. The answer was found by using approved vehicles that were sealed by Customs and by using a TIR carnet for security, the equivalent of the earlier carnet de passage.

21

The TIR Convention was revised in 1975, taking into consideration technological progress at the time, and since then the TIR Convention has been updated 27 times. The most recent amendments came into force on 12 August 2006. If you access the UNECE homepage on the web, (<http://www.unece.org/trans/bcf/tir/convention/amend.htm >) you will see evidence of these amendments. What is the TIR? It is simply a form of Customs security which demands approved, secure vehicles and a particular form of sealing.

5.3.2. The Customs Convention on the ATA Carnet for the Temporary Admission of Goods (ATA Convention) While the TIR Convention is concerned about goods moving through a Customs territory free of duties and taxes, the ATA Convention goes further in permitting the duty-free and tax-free temporary import of goods for up to one year. The International Chamber of Commerce (ICC) in Paris developed the ATA Carnet system for the convenience of business people going overseas and taking business related goods with them. The collective initial ATA is an acronym of the French and English words Admission Temporaries/Temporary Admission. Carnet is a French word meaning book of tickets (or stubs).

22

Since then the system has developed and is commonly used by tourists to provide security for the temporary importation of motor vehicles and other goods. Carnets cover just about all goods, personal and professional, including commercial samples, professional equipment, and goods intended for use at exhibitions and fairs. In addition, the following are included: Goods such as computers, tools, cameras and video equipment, industrial machinery, automobiles, jewellery, and wearing apparel; and Items, for example, fine art, circus animals, aircraft, musical instruments, racing yachts, racing motor vehicles, satellites, and the like. Carnets do not cover consumable goods (food and agricultural products), or disposable items. 5.3.3. The Revised Kyoto Convention Specific Annex E The early provisions outline the routes for transit cargos, establish that transit cargos are not taxable, and allocate responsibilities. Standard 3 establishes the principle of relief from taxes for goods passing through a territory under the terms of Transit. The taking of security may occur. In Mozambique, for example, the Transit regime requires security to be furnished on a scale in relationship to the value of the consignments. Regular transporters may make use of a Global security
23

arrangement, while casual traders are required to lodge securities (usually in cash) for individual loads. This arrangement recognizes the revenue risks inherent in cross border traffic. Recommended Practice 5 The Customs should approve persons as authorized consignors and authorized consignees when they are satisfied that the prescribed conditions laid down by the Customs are met. Recommended Practice 5 acts in concert with General Annex Transitional Standard 3.32, Special procedures for authorized persons. Both provisions provide facilitation to regular and reliable traders, with a minimum of intervention. There will be an agreed procedure statement between the authorized persons and the Customs covering the approved activities. Customs will monitor operations and carry out spot checks as required. Transit operations are not simple consider the requirements that are dealt with in the provisions of Kyoto Annex E, Chapter 1: The goods declaration; Sealing of consignments & when sealing is not required; Transport units; Time limits; Changes in destination; Transfers; Mixed consignments;
24

 Accidents; and Termination notification. To achieve even greater security of transit shipments, the accounting of imported and exported goods through computerization should be extended to transit consignments. Recommended Practice 9 does not necessarily require the transport unit to be approved in advance, although it tends to indicate that units should be approved at some stage. The design of the transport-unit is not the factor. It is the construction of the unit which must be such that security is provided when Customs seals are affixed. The guidelines to this recommended practice state that: If transit is carried out under Customs seal, the transport-unit must meet certain construction and fitting conditions so that the affixing of the seal does not provide merely illusory security. The reason for which the transport-unit was sealed is not a decisive factor. Approval of a transport-unit consists of examining whether it meets the Customs security requirements and preparing a certificate, generally valid for a limited period, certifying that it is considered suitable for transport under Customs seal. It is up to Customs to examine the transport-unit and to draw up the approval Unless expressly required by other international agreements, approval of the transport-unit is not mandatory for transport under Customs seal. 5.4. Transshipment
25

Transshipment is a national procedure, not international. Chapter 2 of Specific Annex E defines Transshipment: The Customs procedure under which goods are transferred under Customs control from the importing means of transport to the exporting means of transport within the area of one Customs office which is the office of both importation and exportation. The definition is quite specific in indicating only one Customs office, and therefore covers goods arriving in Auckland on the vessel Blue Star, that are unloaded and then transported under Customs control to be loaded for export onto the vessel Red Star situated on the other side of the port. If the goods were transported under Customs control to the port of Wellington or to the airport for export, the procedure would be that of Transit. Consider what would happen if the vessel Red Star was not scheduled to arrive for another week. Can transshipment still occur? Summary Transit/Transshipment The message within the Kyoto provisions for transshipment is one of reason. Under normal circumstances, the transshipment process does not pose significant risks simply because the goods stay within the same port under the control of the Customs. Transit and Transshipment are exercises in accounting what is reported coming in should be accounted for going out. Overall, these two Customs processes, Transit and Transshipment, are important in supporting the Customs responsibility for securing the revenue. The processes, furthermore,
26

offer significant trade facilitation. Imagine the bureaucracy that would exist if goods could not move throughout Europe under TIR guaranteed transit. 5.5. Temporary Admission

One of the most important chapters of the Revised Kyoto Convention is Chapter 1 of Specific Annex G, which deals with goods entered under temporary admission regimes. International Customs Law has long recognized that there is a need for certain goods to be able to enter a Customs territory for a limited period of time and then to be removed from the territory, unchanged, and without any duty liability arising. The first conventions on temporary admission were created in the 1950s, referring to goods such as commercial samples and advertising materials, motor vehicles, aircraft and pleasure boats, tourist-related materials and so on. In 1961, Conventions on the importation of goods for displays and exhibitions, and temporary importation of professional equipment came into being. Other Conventions relating to containers, pallets and packaging became necessary in the early 1970s. By 1990, it became clear that these various rules needed to be brought together in the one convention, and in 1990 the Convention on Temporary Admission (Istanbul Convention) was created. The purpose of the Convention is to harmonize and simplify procedures relating to temporary admission. The Convention also gives added legal status to the ATA Carnet Convention, which was established in 1961. It requires each contracting party to accept the ATA carnet in lieu of its national Customs documents and as security for payment of the duties and taxes which would otherwise
27

be payable. The ATA Carnet has therefore become a form of global clearance document for temporary admission, a significant step forward in simplifying and harmonizing Customs procedures. The carnet itself is issued by the International Chamber of Commerce. The full extent of the way in which Istanbul has drawn these various conventions and practices together is illustrated by the Guidelines to Chapter 1 of Specific Annex G. The Kyoto Convention builds on the Istanbul Convention and encourages parties to become parties to the Istanbul Convention. Chapter 1 of Annex G is a large chapter, designed to reinforce five key principles: Goods that are granted temporary admission status are intended to be exported once the term of the temporary admission has been completed; The goods must be identifiable so that Customs is able to ensure that the goods presented at re-exportation are the same as those which were presented at temporary importation; Securities may be required to cover the risk that the goods will not be exported but will enter into local consumption without authorization; Customs will specify a time limit at which point the goods must be exported;
28

 In principle, the goods can circulate freely within the country, but their use is limited to the purpose of the temporary admission. Thus goods imported for display purposes only cannot be put to other uses. The Standards and Recommended Practices of Annex G expand on these five principles.

5.6.

Customs Warehouses and Free Trade Zones

5.6.1. Some Introductory Terminology When goods enter, move about, and exit a Customs territory, they will also move in and out of Customs control. This means that we need to know the status of goods at any particular time and to understand the different rules that apply, depending on their status. Most Customs legislation will spell out in detail the principles that are set down in the Kyoto Convention. In most cases, the goods will be brought into the Customs territory before the goods declaration has been lodged, and may be in the territory for some time before the declaration is lodged. A number of formalities need to be undertaken upon the act of importation, including the lodgment of a cargo declaration or manifest. Where goods are offloaded from a ship but have not

29

yet been cleared to move off the wharf, they will be held under Customs control in temporary storage. Often importers will bring goods into a country with the intention that they be sold at a later time. In these circumstances, the goods may be held in storage under a licensed warehouse system. Goods may be entered for warehousing and held there until they are required for home consumption, at which time an entry for home consumption is made and duty paid. Special Free Zones may be created to encourage investment in certain regions of a country and these, too, require careful management by Customs. In other cases, goods may be allowed duty free entry for use in manufacturing processes, subject to their acquittal upon export. If not acquitted, duty will become payable. Drawbacks of import duty are allowed where goods are exported in certain circumstances, and duty was paid on the goods at the time of importation. 5.6.2. Temporary Storage of Goods Temporary storage is governed by Chapter 2 of the Revised Kyoto Convention, Specific Annex A. It is important to draw a distinction here between warehousing and temporary storage. Warehousing occurs after the goods declaration has been lodged and the goods approved for warehousing. Goods are placed in temporary storage after the cargo declaration has been lodged but before the goods declaration has been lodged and the goods cleared. The distinction is also drawn, at the end of the guidelines to chapter 2, between the commercial importances of warehousing, compared with the transport logistics which prompt temporary storage.

30

Because the goods are uncleared, it is important that the storage facility be properly secured so that the goods cannot be removed or dealt with unlawfully. The provisions of Chapter 2 reflect this. It is up to Customs to authorize the establishment of temporary stores (S2) and to ensure proper facilities for storing goods that may be dangerous (RP3). While the cargo declaration should be sufficient documentation for goods in temporary storage (S4, RP5), Customs can lay down requirements as regards the construction, layout and management of temporary stores (S6). Goods can be worked on while in temporary storage to ensure their preservation and preparation for further transport (S7, 8). Customs can impose time limits on the length of storage, and can also extend those time limits as necessary (S9, RP10.) There are also provisions relating to damage caused to the goods while in storage through accident or force majeure. 5.6.3. . Warehousing It is in the nature of international trade that in a great many cases it is not known at the time of importation how those goods will finally be dealt with. This means that the importers are obliged to store the goods for greater or shorter periods. Where it is intended to re-export the goods, it is in the importers interest to place them under a Customs procedure that doesnt require the payment of duties and taxes. If, on the other hand, goods are intended for the commerce of the importing country, it is again in the importers interest to be able to delay payment of duties and taxes until the goods are actually taken into home use. In order to make these facilities available to importers, most countries have provided in their national legislation for the Customs warehouse procedure.
31

However, imported goods are not the only goods which may qualify for Customs warehousing. Some countries allow storage in Customs warehouses of goods that are liable to, or have borne, internal taxes, in order that they may qualify for exemption from, or repayment of, such taxes. We have already distinguished between goods in temporary storage and goods that are warehoused the one happens before the goods are entered, the other afterwards. We also need to distinguish between goods that are in warehouses and goods that are in Free Zones, as the latter have greater freedom of movement and use and are subject to different provisions within the Convention. Chapter 1 of Specific Annex D covers warehousing, while Chapter 2 of the same Annex covers Free Zones. It is also worth pointing out that in many countries, duty free stores are essentially the same as Customs warehouses. The goods remain in bond until sold under the special circumstances of duty free operations (normally in anticipation of export and consumption outside the country of sale). Thus, goods are imported into the warehouse duty free and sold to overseas travelers without a duty liability arising. If the goods are incorrectly dealt with and sold into domestic use rather than for export, then a duty liability will arise. Chapter 1 of Specific Annex D contains some 16 Standards and Recommended Practices relating to Warehousing. Standards 2 and 3 establish the basic principle that there are two types of Customs warehouses public and private and that national legislation shall provide for these warehouses and who shall have the right to use them. Public warehouses are
32

open to any person who has the right to dispose of the goods stored in the warehouse. Private warehouses allow specified persons to store goods in these warehouses for their own specific uses. Private warehouses are often close to, or on the manufacturing premises of, the persons concerned such as a bond store in a distillery. The dutiable spirits produced there can be held in bond before their release into consumption, at which time the duty becomes payable. Once the two types of warehouse have been established, the Chapter then goes on to provide that the Customs has the power to establish rules and procedures for the management of Customs warehouses (Standard 4).Essentially all imported goods are entitled to be warehoused in public Customs warehouses without discrimination, except where the goods are proscribed on grounds of public morality or order, security, hygiene or health, or for veterinary or phytosanitary considerations (RP5). Customs shall specify what goods can be stored in a private warehouse (S6). The Chapter then sets out several recommended practices relating to the warehousing of goods that have been introduced into the Customs territory under specific duty exemption or duty refund regimes such as temporary admission. Finally, the remaining standards deal with: 1. Authorized operations on the goods while in the warehouse (S10) ; 2. Transfer of ownership of warehoused goods (S12); 3. Deterioration of goods (S13); 4. Removal of goods (S14) ; 5. Procedures where goods are not removed (S15); 6. Closure of Customs warehouses (S16);
33

5.6.4. Duty Free Zones A free trade zone (or foreign trade zone, free port, free warehouse, etc.) is a special commercial/industrial area, usually in or near a port of entry where foreign and domestic goods, including raw materials, components, and finished goods, may be brought in without being subject to payment of Customs duties. Goods brought into these zones may be stored, sold, exhibited, repacked, assembled, sorted, graded, cleaned, or otherwise manipulated prior to re-export or entry into home consumption. Such zones are often utilized to encourage the development of export trade and international commerce in general, although their utility has decreased as international tariffs have been reduced. Specific Annex D establishes in Chapter 2 more than 20 standards and recommended practices relating to the establishment of Duty Free Zones. Free Zones can be of many different types and sizes, ranging from large ports and surrounding territory to relatively small industrial estates. The biggest issue in compliance terms for Customs services is to ensure that goods enter and leave the zones legitimately - either they are exported properly, or duty is paid if the goods enter domestic use. Therefore, while zones encourage a facilitative approach to trade, they still require effective regulatory measures to ensure proper compliance. It is common practice for securities to be used to provide guarantees in the event that goods are mishandled. Free Zones also lend themselves to effective risk managed compliance based on post transaction auditing, as recommended in Chapter 6 of the General Annex.

34

5.6.5. Inward (and Outward) Processing Free Zones provide one form of entry of goods for manufacturing processes. Another form of entry is inward processing. In this case, goods are provided conditional relief from duties and taxes because they are going into a manufacturing process, after which they will be exported. This is similar to free zones, except that the goods are in general circulation within the country. The practice is highly facilitative, but also requires Customs to maintain effective controls to identify circumstances where goods imported under the concession may in fact not be exported, thereby establishing a liability in the importer to pay the duty and taxes owing. Chapter 1 of Specific Annex F sets out the principles to govern inward processing. The flip-side of inwards processing is outwards processing, in which goods are exported for manufacturing or repair, and then re-imported. These goods are often totally or partially exempt from duties and taxes on re-importation. The principles governing outwards processing are set out in Chapter 2 of Specific Annex F. Please also look at Chapter 4 of Specific Annex F, which provides for the Processing of goods for home use in which goods may be imported duty free, manufactured in the country, and then entered for domestic use. In these circumstances, the net duty and tax payable may be less than if the duty were payable at the time of importation, thereby providing relief to the manufacturer and an incentive to continue production in the country.

35

CHAPTER SIX CUSTOMS TECHNIQUES

Harmonized Commodity Description and Coding System (the HS) Customs duties are imposed on the act of importation of goods. On some goods, Customs duties are also charged on the act of exportation. This division and enumeration of all goods entering international trade, along with well-defined rules of interpretation, form what is normally called the nomenclature of goods in a country. Governments use the nomenclature as the basis for prescribing appropriate duty on goods imported and/or exported. The nomenclature combined with the duty rates is called the Tariff. As the tariff is normally a part of the Tariff Act in a country, it is generally called the Tariff Schedule. A good nomenclature of goods should ensure that:
36

 Every product manufactured or otherwise is covered under a code number uniformly applied globally; A set of rules is available for interpretation; and A statistical base suitable for electronic collection is available. What is the HS? The HS is the product of an international convention (the International Convention on the Harmonized Commodity Description and Coding System) aimed at promoting uniformity of description of goods for tariff purposes amongst trading nations. It does not deal with the rates themselves but merely the categories that apply to goods. It entered into force on 1 January 1988, under the auspices of the Customs Cooperation Council in Brussels. The HS operates as a global language and code for transportable goods in international trade. Approximately 175 countries and economic unions use the HS for Customs tariffs and trade statistics. This accounts for more than 98% of world trade. The HS is used by governments, international organizations, and the private sector for diverse purposes including: Trade policies; Monitoring of controlled goods; Rules of origin; Freight tariffs; Transport statistics; Internal taxes; Quota controls; and
37

 Economic research and analysis. The HS is an international 6-digit commodity classification system. The World Customs Organization (WCO), for purposes of uniform interpretation of the HS, has published detailed Explanatory Notes. These form the basis for interpreting the HS. Recommended interpretations, amendments, and explanatory notes are prepared by the Harmonized System Committee, which represents the contracting parties to the Harmonized System Convention. The Explanatory Notes comprise five volumes and, although not integrated with the HS Nomenclature, they complement the HS in that they are the official interpretation of the HS structure. The Explanatory Notes follow the systematic order of the 96 Chapters of the HS. They: Provide a commentary on the scope of the headings and where appropriate, subheadings; Provide a commentary on the meaning of legal notes; Provide a commentary on the meaning of the Interpretative Rules; List the main products that are included within headings; List products that are excluded from headings; Provide technical descriptions (appearance, characteristics, and uses) of goods; Provide guidance for the identification of goods.

38

Although they are not legally binding, the Explanatory Notes are an important part of the HS reference material and should be used to ascertain the correct interpretation and scope of the texts of the Nomenclature. The Structure and Obligations of the HS Convention There are approximately 5,000 categories of goods in the Harmonized System. To provide a comprehensive categorization covering all imported goods, there is a need for different levels of classification to progressively divide the goods until the appropriate level of classification is found and the duty rate applied (by domestic legislation).The HS Convention consists of 20 Articles and an Annex. The Articles govern the procedures for the running of the Convention. It includes: The obligations of its members (Article 3); The particular requirements of developing country members (Article 4); The provision of technical assistance for developing country members (Article 5); The provision for the establishment of committees, in particular the Harmonized System Committee (Article 6); The provision to allow for amendments to the Harmonized System Nomenclature and its supporting documents (Article 7); The protocol for the settlement of classification disputes (Article 10). Harmonized System Nomenclature
39

The HS Nomenclature is the Annex to the Convention. Under Article 1, the Nomenclature comprises: 4-digit classifications called headings and their goods descriptions; 5- and 6-digit classifications called subheadings and their goods descriptions; Legal notes that are applicable to both headings and subheadings; The rules for the classification of goods, called Interpretative Rules. The headings and subheadings are grouped into 96 Operating Chapters, which are further divided into 21 sections. The legal notes are located at the beginning of nearly all the Chapters and some of the sections. The headings are the core of the HS classification hierarchy. Legislation giving effect to the HS in each country will contain a tariff schedule(s) where commodities are arranged in a fixed pattern with the duty rates specified against each of them. The pattern of arrangement of goods in the Tariff Schedule is in the increasing degree of manufacture involved, that is, natural products followed by raw materials, semi-finished goods, and then, fully finished goods. The HS has a built-in system of continual amendment. This is an essential requirement, as goods that are traded are in constant change, whether as the result of varying demand or as the result of the progress of technology. In an effort to keep pace with change, the HS has a five-year review cycle. Since its inception the HS has undergone three major reviews, with the third review being implemented on 1 January 2007.
40

The Tariff Classification Process The actual task of classifying goods under a Tariff is often perceived as something of a dark art. Certainly, it can be a difficult and highly technical process at times. It is not the intention of this particular course to create tariff technical experts so we wont be studying classification in detail. Nevertheless, it is important for anyone engaged in international trade to have some understanding of the steps that are undertaken to identify and classify particular goods to specific tariff items and hence, specific rates of duty. Over the years, principles have been developed, both by the World Customs Organization and by Customs administrations around the world. Legal precedent has also been established by way of classification decisions that have been handed down by various courts and tribunals. However, the classification process can be reduced to two separate steps. They are: 1. Identification of the goods; and 2. Use of the interpretative rules. These two steps may be further broken down into five stages or processes. They are: 1. Identify the goods; 2. Identify/locate areas, namely, the sections and chapters, within the Nomenclature where the goods may fall; 3. Identify and select appropriate headings within these areas; 4. Classify the goods at heading level, taking account of any relevant legal notes; and
41

5. Classify the goods at subheading level, taking account of any relevant subheading notes. Although there is some overlap between the stages, the identification phase can be said to encompass the first three processes. Process four is set out within the directives of Interpretative Rule 1, with the final process being governed by Interpretative Rule 6. Interpretative Rules The Interpretative Rules are paramount in the classification of goods. The following is a brief outline of the Rules. Rule 1 gives precedence to the Section notes/Chapter notes. Rule 2(a) applies to goods imported in assembled/unassembled condition. Such goods may be in incomplete or finished form. Rule 2(b) is applicable to mixtures and composite goods. Goods which are not classifiable by application of Rule 2(b) will have to be classified by application of Rule 3, which has three sub-rules that apply in descending order most specific description, essential character, and last occurring tests. Rule 4 directs that goods, which cannot be classified by application of the preceding rules, may be classified under the heading appropriate to the goods to which they are most akin. Rule 5 applies to packing materials/articles in which the goods are carried. Rule 6, as outlined previously, provides the general guideline for classification of goods under the appropriate subheading. Some additional principles that can be distilled from legal precedent should also be borne in mind when classifying goods:
42

 It is the goods themselves, in the condition in which they are imported, to which it is generally necessary to look to determine their identification for purposes of Customs duty; and In many instances, identification of goods will involve determining their essential character, particularly when classifying mixed goods or goods with more than one function. Even though the general principle is that classification should not occur by reference to end use, the tariff descriptions will sometimes refer to suitability for a particular use as the core characteristic upon which to base classification. Actual end use is not relevant. Rather it is the objective features of the goods that show suitability for particular uses that are an issue. When considering the use to which goods are designed to be put, the intentions of the designer or vendor are not relevant. It is the features of the goods that are the determinant. In addition, it is the normal use of the goods that is relevant and not possible use. Customs Valuation Article VII of GATT 1994 deals with Customs valuation. The WTO Agreement also includes an Agreement on Implementation of Article VII of the GATT 1994, which supersedes the previous Tokyo Round Code dealing with the same issue. Like other international agreements, domestic legislation is needed to implement the Valuation Agreement in each country. This domestic
43

legislation can be quite complex. For example, in Australia, Section 161 of the Customs Act 1901 stated that the transaction value of goods is equal to the sum of their adjusted price in the import sales transaction and of their price related costs to the extent that those costs have not been taken into account in determining the price of the goods. Then, over 40 separate definitions have to be read to decipher this short definition. Types of Customs Duties Most countries levy ad valorem duties. Governments prefer to levy such duties for three main reasons: First, it is easier for the authorities to estimate the amount of duty payable from ad valorem duties, which are assessed on the basis of value, rather than revenue from specific duties, which are levied on the basis of volume or weight; Second, ad valorem duties are more equitable than specific duties as their incidence is lower on cheaper products and higher on more expensive goods. For example, a specific duty of $2 per liter would have an incidence of 50% on a bottle of wine costing $4, and 5% on a higher-priced wine costing $40 per bottle. An ad valorem duty of 10% would have an incidence of 40 cents on the cheaper bottle and $4 on the more expensive bottle; Third, in international negotiations for reductions in tariffs, it is far easier to compare the level of tariffs and negotiate reductions if the duties are ad valorem.
44

However, it is likely you will find some specific rates (e.g. $2 each) or occasionally a combined specific rate and ad valorem rate (e.g. $1000 per vehicle plus 25%). The Legal Hierarchy of Customs Valuation At the top of the hierarchy is Article VII of the GATT, which sets out the fundamental rules on Customs valuation. Then there is the Agreement on Implementation of Article VII, which is one of the WTOs families of agreements stemming from the Uruguay Round. There is a General Introductory Commentary and several interpretative notes which are attached to the Agreement as Annex 1 these are intended to assist in the interpretation of the key provisions of the Valuation Agreement. Article XIV stresses that the interpretative notes are an integral part of the Agreement. Finally, there is the legislation that each country has put in place to give effect to its international obligations. This legislation may differ slightly from country to country in the way that value is to be calculated by stipulating whether value is based on CIF or FOB price, or by deciding what costs will be regarded as part of the price and what costs are not so regarded. What is Value? The first important point to note is that the notion of Value is an uncertain concept. We may value things in quite different ways and for quite different reasons. In designing a valuation system for Customs duty purposes, there are a number of alternatives that are available. The simplest evidence of
45

value would be the price actually paid for imported goods. This is the easiest to manipulate however. For example, a multinational group of companies that transfers goods between related parties as part of an international distribution system might put unduly low prices on their invoices simply to avoid paying Customs duties. On the other hand, low value should not necessarily lead to suspicion. The aim of buyers is to secure the lowest possible price. The fact that individual transactions might appear to be below traditional market norms should not be a cause for rejection of the invoice price. In designing a valuation system, we are again faced with the various conflicting goals that permeate the Customs area. We would like our legislation to be efficient, in the sense of assisting in the accurate assessment of proper levels of Customs duty with minimal additional transaction costs or adverse effects on international trade. We also want our system to be one which minimizes avoidance and evasion activities. A Short History of Customs Valuation Article VII of the General Agreement on Tariffs and Trade (GATT) laid down the general principles for an international system of valuation. It stipulated that the value for Customs purposes of imported merchandise should be based on the actual value of the imported merchandise on which duty is assessed, or of like merchandise, and should not be based on the value of merchandise of national origin or on arbitrary or fictitious values. Although Article VII also contains a definition of actual value, it still permitted the use of widely differing methods of valuing goods. In addition,
46

grandfather clauses permitted continuation of old standards which did not even meet the very general new standard. Brussels Definition of Value Starting in the 1950s, Customs duties were assessed by many countries according to the Brussels Definition of Value (BVD). Under this method, a normal market price, defined as the price that a good would fetch in an open market between a buyer and seller independent of each other, was determined for each product, according to which the duty was assessed. Actual variations in this price were only fully taken into account where the declared value was higher than the listed value. Downward variations were only taken into account up to 10%. This method caused widespread dissatisfaction among traders, as price changes and competitive advantages of firms were not reflected until the notional price was adjusted by the Customs office after certain periods of time. More often than not, changes in technology and innovation were not captured in the lists, which made determination of the normal price difficult. The United States never became part of the BVD, and it was clear that a better method was needed. Tokyo Round Valuation Code This Code, or Agreement on the Implementation of Article VII of the GATT, concluded in 1979, established a positive system of Customs valuation based on the price actually paid or payable for the imported goods. Based on the transaction value, it was intended to provide a fair, uniform and neutral system for the valuation of goods for Customs purposes, conforming to commercial realities. As a stand-alone Agreement, the Tokyo Round Valuation Code was signed by more than 40 Contracting Parties.
47

The WTO Agreement on Implementation of Article VII of the GATT 1994 This Agreement replaced the Tokyo Round Code following conclusion of the Uruguay Round, and applies only to the valuation of imported goods for the purpose of levying ad valorem duties on such goods. The Agreements valuation approach is based on simple and equitable criteria that take commercial practices into account. By requiring all member countries to harmonize their national legislation on the basis of the Agreements rules, it seeks to ensure uniformity in the application of the rules so that importers can assess with certainty, in advance, the amounts of duties payable on imports.

The Basic Principle: Transaction Value The basic rule is that the value for Customs purposes should be based on the price actually paid or payable when sold for export to the country of importation (for example, the invoice price), adjusted, where appropriate, to include certain payments made by buyers such as the costs of packing and containers, assists, royalties, and license fees. The rules exclude buying commissions and special discounts obtained by sole agents and sole concessionaires from being taken into account in arriving at dutiable value (Articles 1 and 8). For the Customs value to be the transaction value (method 1 of valuing), all of the following conditions have to be fulfilled: There must be evidence of a sale for export to the country of importation;
48

 There must be: (a) no restrictions as to the disposition or use of the goods by the (i) Are imposed or required by law in the country of importation; (ii) Limit the geographic area in which the goods may be resold; or (iii) Do not substantially affect the value of the goods; (b) the sale or price is not subject to some condition or consideration for which a value cannot be determined with respect to the goods being valued [for example, the seller establishes the price of the imported goods on the condition that the buyer will also buy other goods in specified quantities]; (c) no part of the proceeds of any subsequent resale, disposal or use of the goods by the buyer will accrue directly or indirectly to the seller, unless an appropriate adjustment can be made in accordance with the provisions of Article 8 (WTO 1994, Part I, Rules on Customs valuation, Article 1). Sufficient information is available to enable the specific adjustments to be made under Article 8 to price paid or payable; The buyer and seller are not related, but if they are, the use of the transaction value is acceptable if the importer demonstrates that: The relationship did not influence the price; or The transaction value closely approximates a test value. (Note: the definition of related persons is found in paragraph 4, Article 15 of the Agreement.) buyer other than restrictions which:

49

How Should Customs Determine Dutiable Value When It Decides To Reject Transaction Value? For cases in which there is no transaction value, or where the transaction value is not acceptable as the Customs value because the price has been distorted, the Agreement lays down five other methods of Customs valuation, to be applied in the prescribed hierarchical order: The transaction value of identical goods (Article 2) method 2; The transaction value of similar goods (Article 3) method 3; The deduction value (Article 5) method 4; The computed value (Article 6) method 5; Fallback method (Article 7). method 6. Under methods 2 and 3, the transactions selected must relate to imported goods that were sold for export to the country of importation at about the same time as the goods being exported. The sequence of methods 4 and 5 (deduction and computed methods) can be switched at the request of the importer but not at the discretion of a Customs officer. The deduction value (method 4, Article 5) is determined on the basis of the unit sales price in the domestic market of the imported goods being valued, or of identical or similar goods, after making deductions for such things as profit, Customs duties and taxes, transport and insurance, and other expenses incurred in the country of importation. The computed value (method 5, Article 6) is determined by adding to the cost of producing the goods being valued an amount for profit and general
50

expenses equal to that usually reflected in sales of goods of the same class or kind as the goods being valued which are made by producers in the country of exportation for export to the country of importation. The fallback method (method 6, Article 7) is used where Customs value cannot be determined by any of the four previous methods. It is determined by using any of the previous methods in a flexible manner, provided the criteria employed are consistent with Article VII of GATT 1994. The value so fixed should not, however, be based on the following factors, among others: The price of goods for export to a third country market; Minimum Customs Values; Arbitrary or fictitious values. In order to ensure that the importer is not subjected to unnecessary burdens, the Agreement suggests that the computed value standard should be used only when buyer and seller are related, and the producer is prepared to provide to the Customs authorities in the importing country the necessary cost data and facilities for their subsequent verification. Other Provisions of the Valuation Agreement The primary purpose of the Valuation Agreement is to set out the methods for calculating value, but the Agreement also contains other important provisions. In summary, these are: Article 9 on currency conversion; Article 10 on confidentiality of commercial information; Article 11 on rights of appeal against valuation decisions;
51

Article 12 on the need for transparency of legislation and other documents relating to valuation; Article 13 on release of goods upon payment of a surety where a valuation decision may otherwise delay release of goods; Article 15 on definitions; and Article 16 on provision of written reasons for decision. Parts II, III and IV set out a number of key provisions relating to matters such as administration of the Agreement, consultation, dispute settlement (by which the Dispute Settlement Understanding is made applicable to the Agreement), special and differential treatment for developing countries, and final provisions on things like amendment and accession. Annex II establishes a Technical Committee on Valuation which meets to ensure uniformity in interpretation and application of the Agreement. Annex III establishes further grounds on which developing countries can delay implementation. Rules of Origin Definition What are Rules of Origin? Rules of origin are the criteria needed to determine the national source of a product. Being able to determine the country of origin of imported goods is important for a number of reasons including tariffs, quantitative restrictions, anti-dumping and countervailing duties, safeguard measures, trade marks, public procurement, and statistical purposes.

52

These objectives are given effect through the application of basic or nonpreferential rules of origin. Countries that offer zero or reduced duty access to imports from certain trade partners will often apply a different set of preferential rules of origin to determine the eligibility of certain goods for reduced duty rates. There are two types of rules of origin, non-preferential and preferential rules: Non-preferential Rules of Origin are used to distinguish foreign from domestic goods for the purpose of applying other trade policy instruments as outlined above; for example, origin marking requirements. Non-preferential rules of origin apply to the approximately 55% of world trade that is conducted on a nonpreferential basis. Unlike preferential rules of origin that have so far escaped broad multilateral regulation, non-preferential rules of origin have been under a process of harmonization since 1995, as mandated by the Uruguay Rounds Agreement on Rules of Origin; Preferential Rules of Origin are employed in preferential trade arrangements such as free trade agreements and in the context of generalized systems of preferences (GSP) to define the conditions under which the importing country will regard a product as originating in an exporting country and will receive preferential treatment from the importing country.

53

We are going to examine non-preferential and preferential rules of origin in turn: how they operate, what issues arise with their usage, and international approaches to their regulation. Background Historically, GATT had no specific rules governing the determination of the country of origin of goods in international commerce. Each contracting party was free to determine its own origin rules, and could even maintain several different rules of origin depending on the purpose of the particular regulation. The drafters of the General Agreement stated that the rules of origin should be left: Within the province of each importing country to determine, in accordance with the provisions of its law, for the purpose of applying the most-favoured nations provisions (and for other GATT purposes), whether goods do in fact originate in a particular country. Article VIII:1(c) of the General Agreement, dealing with fees and formalities connected with importation and exportation, states that the contracting parties also recognize the need for minimizing the incidence and complexity of import and export formalities and for decreasing and simplifying import and export documentation requirements. The Interpretative Note 2 to this Article states that it would be consistent if, on the importation of products from the territory of a contracting party into the territory of another contracting party, the production of certificates of origin should only be required to the extent that it is strictly indispensable.

54

Nevertheless, it was accepted by all countries that harmonization of rules of origin would facilitate the flow of international trade. During the Uruguay Round, participating countries recognized the need to provide transparency of regulations and practices regarding rules of origin in order to prevent unnecessary obstacles to the flow of international trade. This led to an Agreement on Rules of Origin, which stipulated that a work program to harmonize non-preferential rules of origin should be completed within three years of initiation, that is, by 20 July 1998. However, due to the complexity of issues raised during the work program, the time schedule laid down in the Agreement was extended, and WTO Members strongly committed themselves to complete the Harmonization Work Program by November 1999. At this point in time (mid 2006), the program has not yet been completed, and confronts some difficult political issues that we will examine in more detail later. The international institutions carrying out the Program have been the WTO Committee on Rules of Origin, which reports to the WTO Council for Trade in Goods, and the WCO Technical Committee on Rules of Origin, which was established under the auspices of the WCO to undertake the technical work. Membership of both Committees is limited to members of the WTO; however, the WCO Technical Committee admits as observers those WCO members that are not WTO members, as well as some international organizations including WTO, OECD, UNCTAD, the UN Statistical Division, the UN Law of the Sea Convention Secretariat, and the International Chamber of Commerce (ICC).

55

The WTO Agreement on Rules of Origin The WTO Agreement is in four parts, and has two Annexes: Part I provides definitions and coverage; Part II contains rules on Disciplines to Govern the Application of Rules of Origin; Part III contains Procedural Arrangements on Notification, Review, Consultation and Dispute Settlement; Part IV sets out provisions on the harmonization of rules of origin; Annex I establishes the Technical Committee on Rules of Origin; and Annex II sets out the common declaration with regard to preferential rules of origin. In general terms, the country of origin of a good is the country where it was wholly obtained or, if more than one country is involved, the country where it was substantially transformed. There is a general acceptance of what is meant by a wholly obtained good but substantial transformation remains problematic. During the Uruguay Round, three tests for substantial transformation were recognized, but it did not prove possible to reach agreement on one single determinant of origin. Article 2 therefore sets out three tests: The change of tariff classification test where a good is so transformed in a country that it changes its tariff classification (for example, the conversion of leather into shoes);

56

The ad valorem percentage criterion where the good has to be so substantially transformed that a defined percentage (usually 50%) of its value is added in the country of manufacture; and The criterion of manufacturing or processing where the basic process of manufacture occurs. Article 2 does not attempt to define each of these tests, but sets out criteria under which they are to be administered. Furthermore, Article 2, paragraph (c) requires that rules of origin shall not themselves create restrictive, distorting or disruptive effects on international trade. As outlined previously, the Agreement also contains two Annexes. Annex I establishes a Technical Committee on Rules of Origin, and Annex II contains a Common Declaration with regard to Preferential Rules of Origin, which we will examine next week. Achieving Harmonization of Rules the Problems The positive aspect of the WTOs work program on rules of origin is the fact that the rules of origin for the approximately 5,000 products in the HS Tariff at 6-digit level are nearing completion. The sobering aspect, however, is the fact that the remaining issues preventing harmonization are the most politically sensitive. The main difficulties can be divided into three broad areas:

57

Issues at the heart of differences between WTO members in how they conceive certain product-specific rules of origin, for example, machinery; Broader differences in trade policy between WTO members, for example, sanitary and phytosanitary standards, the exclusive economic zone, and trademarks; and Disagreements over the application of rules of origin in anti-dumping actions. In relation to the first area of difficulty, the United States favours change in tariff classification and/or technical requirement as the most appropriate rules of origin in machinery, while Europe supports rules of origin which are based on value added. Besides assembled industrial products, there are other sectoral rules of origin involving agricultural and industrial products such as pizzas, refined vegetable oils, fruit juices, wines, cement, pharmaceuticals, leather, and iron and steel. The central issues relate to the type of processing or manufacturing that is sufficient to confer origin, and the extent to which a given countrys input share in a final product suffices to assign origin to that country and not to others whose materials are used in the product. Products such as pharmaceuticals involve both issues. In relation to the second area of difficulty there are three issues. Firstly, the definition of rules of origin will have implications for the application of many other international trade policy instruments. Secondly, negotiators on rules of origin have the very difficult task of making rules of origin as compatible as possible with the other WTO Agreements. Thirdly, movement on the rules of origin front can be contingent on movement on much broader
58

trade issues. One example of this concerns trademarks. Trademarks are protected as intellectual property by the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). One of the issues in relation to trademarks and rules of origin concerns coffee. Colombia is insistent on its trademark 100% Colombian Coffee; other coffee producers, such as Brazil, oppose the 100% rule on coffee because those countries produce coffee blends. In relation to the third area of difficulty, some WTO members such as the US, Korea and Japan, argue that the calculation of the dumping margin the difference between the price of the exported good and its value in the domestic market is based on the concept of exporting country and not on the country of origin. If this concept is employed, the determination of origin would be unnecessary. The final exporter of a good that has passed through production in various countries on its way to the importers market would be the subject of anti-dumping investigations by the importer. However, according to this concept, countries would be able to use their own notion of origin for anti-dumping investigations without considering harmonized rules of origin; therefore they would also be able to define exporter in broader terms than those allowed by the multilateral non-preferential rules. This would enable such countries to target with the same anti-dumping investigation every country through which a good has passed, rather than targeting only the country defined as the country of origin by the rules of origin. Definition What are Preferential Rules of Origin?

59

When a product is produced in a single process or is wholly obtained from within one country, origin is relatively easy to establish. As mentioned previously, preferential rules of origin are used in preferential trading arrangements such as NAFTA, ANZCERTA, MERCOSUR, and in relation to bilateral free trade agreements. Unlike non-preferential rules of origin, however, they have so far escaped multilateral regulation. The difficulties associated with preferential rules of origin arise particularly in cases where products are manufactured in several stages, and reflect the diversity and political dimensions of international trading policy. Preferential Rules of Origin define the methods by which it can be ascertained that the particular product has undergone sufficient processing or has been subject to a substantial transformation in a partner country, and that it has not simply been transshipped from a non-qualifying country or been subject to minimal processing. Three main methods are used to establish if sufficient processing or substantial transformation has been undertaken: A change of tariff classification; A minimum amount of domestic value-added; or A specific manufacturing process. There are several other typical features of the rules of origin of preferential trade schemes that can influence whether or not origin is conferred on a product. These are: Cumulation; Tolerance rules; and
60

Absorption. Cumulation This is an instrument allowing producers to import materials from a specific country or regional group of countries without undermining the origin of the product. The most basic form is bilateral cumulation. In this case, originating inputs that is, materials which have been produced in accordance with the relevant rules of origin imported from the partner country, qualify as domestic content when used in a countrys exports to that partner country. Second, there can be diagonal cumulation on a regional basis, whereby parts and materials from anywhere in the specified region, which qualify as originating can be used in the manufacture of a final product, which can then be exported with preferences to the partner countrys market. Finally, there can be full cumulation, whereby any processing activities carried out in any participating country in a regional group can be counted as qualifying content, regardless of whether the processing is sufficient to confer originating status on the materials themselves. Tolerance or De minimis Tolerance rules allow a certain percentage of non-originating materials to be used without affecting the origin of the final product. This rule applies to the change of tariff heading and the specific manufacturing rules but does not affect the value-added rules. The tolerance rule makes it easier for products with non-originating inputs to qualify for preference. Absorption
61

The absorption principle provides that parts or materials which have acquired originating status by satisfying the relevant rules of origin for that product can be treated as being of domestic origin in any further processing and transformation. In other words, any non-originating materials are no longer taken into account when assessing the nature of further operations. The Impact of Preferential Rules of Origin on International Trade We have seen that the Uruguay Round Agreement on Rules of Origin contains in Annex II non-binding Common Declaration with Regard to Preferential Rules of Origin requiring members to refrain from adopting rules of origin with protective intentions that may harm the interests of third countries. Yet this is exactly what has taken place in preferential trade agreements negotiated by two of the largest members. Restrictive domestic content and processing requirements have been adopted in framing the rules of origin governing textiles and apparel, in preferential trade agreements negotiated by both the US and the EU. In effect, it adopts a 100% local content rule. The point to note is that rules of origin can be manipulated to achieve less liberal trade objectives, such as the protection of domestic producers of intermediate goods. Restrictive rules of origin raise the costs of supplying the markets of preferential partners firstly, by requiring changes in production that lead to the use of higher cost inputs and secondly, by incurring expenses in proving conformity with those rules. The Customs Context Impact of the Revised Kyoto Convention

62

The Revised Kyoto Convention on the Simplification and Harmonization of Customs Procedures 1999 recognizes two basic criteria to determine origin: wholly obtained or produced, and substantial transformation. The wholly obtained or produced criterion applies to only one preferential trading arrangement member, and determines origin by whether the commodities and related products have been entirely grown, harvested, or extracted from the soil in the territory of that member, or manufactured there from any of these products. The rule of origin is met by avoiding the use of any second-country components or materials. The substantial transformation criterion is more complex as we have seen previously, involving four main components that can be used as stand-alone or in combinations with one another: The first component is a change in tariff classification between the manufactured good and the inputs from other sources. The change in tariff classification may require the product to alter its chapter, heading, subheading or item in the exporting country; The second component is an exception attached to a particular change in tariff classification. The exception generally prohibits the use of nonoriginating materials from a certain chapter, heading or subheading; The third component is value content, which requires the product to acquire a certain minimum local value in the exporting country (or, alternatively, to remain below a certain ceiling percentage of value originating in the non-member countries). The value content can be
63

expressed in three ways: as the minimum percentage of value that must have been added in the exporting country (domestic or regional value content); as the difference between the value of the final good and the costs of the imported inputs (import content); or as the value of parts, whereby originating status is granted for products meeting a minimum percentage of originating parts out of the total; and The fourth component is technical requirement, which requires the product to undergo certain manufacturing operations in the originating country. Technical requirement mandates or prohibits the use of certain inputs and/or the realization of certain processes in production of the good. It is a prominent feature in rules of origin governing textile products. These understandings are contained in Annex K to the Revised Kyoto Convention. It should be noted that most of the provisions in Annex K are Recommended Practices rather than Standards. This means that Member States can enter reservations against them should they so wish.

64