Congressional Research Service 4
Memorandum / August 22, 2011To: / Senate Finance Committee, International Trade, Customs, and Global Competitiveness Subcommittee
Attention: Jayme R. White
From: / Vivian C. Jones, Specialist in International Trade and Finance
Subject: / Textile and Apparel Rules of Origin in Selected Free Trade Agreements
This memorandum is in response to your request for a description of the textile and apparel rules of origin in the free trade agreements in which Australia, Brunei Darussalam, Chile, Malaysia, New Zealand, Peru, Singapore, and Vietnam are trading partners. You indicated that you are especially interested in those free trade agreements to which the United States is not a party. Please feel free to contact me if you require further information.
Rules of Origin in Free Trade Agreements
Rules of origin (ROO) are “the specific provisions, developed from principles established by national legislation or international agreements (“origin criteria”), applied by a country to determine the origin of goods.”[1] There are two types of ROO. First, Non-preferential ROO schemes are used to grant countries Most-Favored-Nation (or MFN) treatment,[2] country of origin marking, government procurement, and to identify (and in some cases limit the quantity of) imports of textile and textile products. In the United States, for example, these rules of origin follow a substantial transformation rule in which the country of origin is the last place in which the imported good was substantially transformed into a new and distinct article of commerce.[3]
Second, preferential ROO apply to special tariff programs such as the African Growth and Opportunity Act (AGOA) or free trade agreements (FTAs).[4] The primary objective of preferential ROO is to ensure that only qualifying products of FTA partners receive the benefits of the FTA.[5] A secondary goal is to limit the impact of the FTA on any domestic industry sector that either FTA party regards as particularly import sensitive.[6] Thus, ROO are included in FTAs to make sure that transshipment and light processing, such as simple assembly or repackaging, are not used by third-country suppliers to circumvent higher duties.[7]
Determining the country of origin is fairly straightforward when a product is “wholly obtained” from one FTA party and transferred directly into the territory of another.[8] However, when a finished product’s component parts and other inputs are manufactured in many countries, determining origin can be a complex process.[9] In order for products to receive the more favorable tariff treatment provided by an FTA, importers must demonstrate that their products meet the ROO criteria.
There are three principal methods used when developing ROO: (1) a tariff-shift test; (2) a regional value content test; and (3) a technical test. Most FTAs make use of a combination of these ROO methods. First, the tariff shift method (also known as a “change in tariff heading” or CTH test) specifies that non-originating component or ingredients incorporated in a product must undergo a tariff shift from one Harmonized Tariff Schedule (HTS) subheading to another.[10] Preferential ROO in the North American Free Trade Agreement (NAFTA), for example, make frequent use of the tariff-shift method.
Second, ROO in many FTAs use a regional value content (RVC) test to ensure that a certain percentage of the value of a manufactured product (as determined by the cost of inputs, labor, and other direct costs of processing operations) originate in the FTA region. When calculating RVC, specific equations are often required to factor in the value of originating materials,[11] the adjusted value of the product, the value of non-originating materials,[12]as well as other costs, such as processing operations and shipping.
Third, a technical test (also known as critical process criterion) requires that certain production or sourcing processes be performed that may (positive test) or may not (negative test) confer originating status.[13]
Preferential ROO are individually negotiated along with other FTA commitments, and are tailored to meet the needs of each trading partner in the agreement. However, since WTO countries have agreed to international disciplines on rules of origin, all FTAs make use of similar methodologies.[14] Therefore, it is possible to use illustrative examples from U.S. FTAs because similar conventions exist in FTAs internationally.
Characteristics of Textile and Apparel ROO
Internationally, the textile and apparel sector has traditionally been very import sensitive, especially when goods are traded between industrialized and developing countries. This was illustrated by the General Agreement on Tariffs and Trade (GATT) and subsequent World Trade Organization (WTO) disciplines. First, under the GATT, multilateral trade in the sector was governed by the Multi-Fiber Arrangement (MFA, expired in 1994) which established quotas limiting the amount of textile and apparel products that could be imported into developed countries from developing countries. The MFA was followed by the Agreement on Textiles and Clothing (ATC), under the WTO, which provided disciplines for the elimination of these quotas by January 2005. [15]
After the expiration of the ATC, countries negotiating bilateral or regional FTAs dealt with import-sensitive tariff lines, such as textiles and apparel, by limiting FTA benefits through the implementation of narrower preferential rules of origin. All of the methods described above have been used to craft textile and apparel ROO. Other technical provisions may also serve to expand or limit the ability of products to satisfy the ROO requirements.
Tariff Shift Test Methodology and “Yarn Forward”
Tariff shift methodology is favored by many, including U.S. customs officials, because they say that it provides an objective method for determining exactly the type of substantial transformation that must occur to determine its origin.[16] U.S. Customs and Border Protection has periodically proposed implementing a more uniform system of non-preferential ROO using the tariff shift method in place of the substantial transformation rule currently used.[17]
The “yarn forward” principle, related to ROO for certain textile and apparel products, is a type of tariff shift test that requires, through the use of a tariff shift, that textile and apparel products must originate in one of the FTA countries from the yarn stage forward (fibers can come from anywhere) in order to qualify for the benefits of an FTA. U.S. FTAs, beginning with the North American Free Trade Agreement (NAFTA), make use of the yarn forward principle, among other things, to limit access to FTA benefits.[18] In some cases, “fiber forward” (the fiber and all operations forward must originate in an FTA country), and “fabric forward” (fabric is required to come from the parties, but that the fibers and yarns may come from anywhere) rules also apply.[19]
The specific terms “fiber forward,” “yarn forward,” and “fabric forward” never actually appear in an FTA. Instead, the tariff shift presented in the ROO indicates the amount of processing required (substantial transformation) in an FTA country in order to confer originating status. Specific ROO for certain products, including textiles and apparel, generally appear in an annex to the FTA, and list various categories of goods by reference to their Harmonized Tariff Schedule (HTS) tariff lines (see Table 1, Table 2 and the text box below)[20] along with a description that provides the degree of shift needed for the product to qualify for FTA benefits.[21] In U.S. FTAs, the “fiber forward” principle generally applies to yarn products and knit fabrics, while “yarn forward” applies to woven fabrics, apparel, and other made-up articles.[22]
Table 1. Harmonized Tariff Schedule Chapters: Textiles and Apparel
Harmonized Tariff Schedule Chapter / Description /Chapter 50 / Silk
Chapter 51 / Wool, fine or coarse animal hair; horsehair yarn and woven fabric
Chapter 52 / Cotton
Chapter 53 / Other vegetable textile fibers; paper yarn and woven fabric of paper yarn
Chapter 54 / Man-made filaments
Chapter 55 / Man-made staple fibers
Chapter 56 / Wadding, felt and nonwovens; special yarns, twine, cordage, ropes and cables and articles thereof
Chapter 57 / Carpets and other textile floor coverings
Chapter 58 / Special woven fabrics; tufted textile fabrics; lace, tapestries; trimmings; embroidery
Chapter 59 / Impregnated, coated, covered or laminated textile fabrics; textile articles of a kind suitable for industrial use
Chapter 60 / Knitted or crocheted fabrics
Chapter 61 / Articles of apparel and clothing accessories, knitted or crocheted
Chapter 62 / Articles of apparel and clothing accessories, not knitted or crocheted
Chapter 63 / Other made-up textile articles; sets; worn clothing and worn textile articles; rags
Source: United States International Trade Commission (USITC). http://www.usitc.gov/tata/hts/bychapter/index.htm.
Table 2. Textiles and Apparel “Tariff Shift” Groupings
Textile Category / HTS Description / Harmonized Tariff Schedule Grouping /Fiber / Silk / 5001 – 5003
Fiber / Wool and Fine Animal Hair / 5101 – 5105
Fiber / Cotton / 5201 – 5203
Fiber / Vegetable Fibers, Paper Yarns, and Woven Paper Fabric / 5301 – 5305
Fiber / Man-made Staple Fibers / 5501 – 5507
Yarn / Silk / 5004 – 5006
Yarn / Wool and Fine Animal Hair / 5106 – 5110
Yarn / Cotton / 5204 – 5207
Yarn / Vegetable Fibers, Paper Yarns, and Woven Paper Fabric / 5306 – 5308
Yarn / Man-made Filaments / 5401 – 5406
Yarn / Man-made Staple Fibers / 5508 – 5511
Fabric / Silk (woven) / 5007
Fabric / Wool and Fine Animal Hair (woven) / 5111 – 5113
Fabric / Cotton (woven) / 5208 – 5212
Fabric / Vegetable Fibers (woven) and Woven Paper Fabric / 5309 – 5311
Fabric / Man-made Filaments (woven) / 5407 – 5408
Fabric / Man-made Staple Fibers (woven) / 5512 – 5516
Fabric / Felt and Non-wovens / 5602 – 5603
Fabric / Specialty Fabrics / 5801 – 5802
Fabric / Knit Fabrics / 6001 – 6006
Source: Harmonized Tariff Schedule of the United States and U.S. Customs and Border Protection, How Do I Read Tariff Shift Rules? And Other Textile and Apparel Rules of Origin Questions You Were Afraid to Ask, Seminar Presentation, October 2007.
Examples of Tariff Shift Rules of OriginFiber Forward
· A change to heading 5101 through 5105 [wool fibers] from any other chapter.
o Wool fiber must be produced in the territory of the trading partners. Because wool fibers are classified in chapter 51, foreign fibers may not be used.
Yarn Forward
· A change to heading 5801 through 5811 [special woven fabrics] from any other Chapter, except from headings 5106 through 5113 [wool yarn and fabric], 5204 through 5212 [cotton yarn and fabric], 5308 [yarn of other vegetable fibers], or 5311 [woven fabrics of other vegetable textile fibers], Chapter 54 [man-made filaments and fabrics], or heading 5508 through 5516 [yarn and fabric of synthetic staple fibers].
o Yarn and fabric must be produced in the territory of the trading partners, but foreign fibers may be used.
Fabric Forward
· A change to heading 5901[coated textile fabrics] from any other chapter, except from heading 5111 through 5113 [woven wool fabrics], 5208 through 5212 [woven cotton fabrics], 5307 through 5308 [woven fabrics of other vegetable yarns (coir yarn, paper yarn, etc], 5407 through 5408 [woven man-made fiber filament fabrics], or 5512 through 5516 [woven man-made staple fabrics].
o Fabric must be produced in the territory of the trading partners, but foreign yarn and fibers may be used.
Source: Harmonized Tariff Schedule of the United States and U. S. Customs and Border Protection, “Textile and Apparel Preference Rules.”
Technical Tests
A technical test requires that a certain procedure must be performed in one or more of the FTA partners. For example, a technical test for processing of yarns and fabrics in the Japan – Malaysia agreement, discussed below, specifies that dyeing and printing processes must be accompanied by two or more additional operations, including antibacterial finish, compressive shrinkage, or waterproofing.[23]
Regional Value Content Requirements
A regional value content (RVC) test requires that a certain percentage of the value of a manufactured product (as determined by the cost of inputs, labor and other direct costs of processing operations) originate in the territory of one or both of the partners. When calculating RVC, specific equations are used to determine the value of inputs originating within the FTA, the value of non-originating inputs, and other costs, such as shipping. Of the agreements discussed below, the China - Peru, European Union - Chile, and the Australia - New Zealand agreements use some type of RVC requirement for some fabric and apparel goods.
FTA Selection and Examination
The countries you requested us to look at are those which are currently negotiating the Trans-Pacific Partnership Agreement (TPP), in which the United States is also participating. We identified over twenty-five FTAs (excluding ASEAN agreements) to which one or more of the countries mentioned above are a party.[24] Providing an analysis of the textile and apparel provisions in each of these agreements is beyond the capacity of CRS to provide in a timely manner. As you suggested, therefore, we are providing a representative sample.
We selected FTAs, first, based on the level of total textile and apparel exports (HTS 50-63) in calendar year 2010 of each of the prospective TPP partners listed above. Of these countries, Vietnam was the largest exporter of textiles and apparel, with total world exports of $12.5 billion in 2010, followed by Australia ($3.4 billion), Malaysia ($2.5 billion), Singapore ($1.8 billion), and Peru ($1.5 billion).[25]
Table 3. Leading Exporters of Textiles and Apparel, 2010
Trans-Pacific Partnership Negotiating Countries, HTS Chapters 50-63
Reporting Country / Value ($billions) /Vietnam / $12.5
Australia / $3.4
Malaysia / $2.5
Singapore / $1.8
Peru / $1.5
New Zealand / $0.9
Chile / $0.1
Source: Global Trade Atlas (GTIS).
Second, we chose representative FTAs that the TPP countries had negotiated with the world’s largest textile and apparel exporters. China heads this list, with total exports of a total of $191.6 billion in textiles and apparel products, followed by the combined EU countries ($138.2 billion), Hong Kong ($33.4 billion), India ($25.6 billion), and the United States ($21.3 billion).[26]
Table 4. Top 20 World Exporters of Textiles and Apparel, 2010
HTS Chapters 50 - 63
Reporting Country / Value ($ billions) /China / $191.6
European Union / $138.2
Hong Kong / $33.5
India / $25.6
United States / $21.3
Turkey / $20.5
South Korea / $12.2
Taiwan / $9.7
Indonesia / $9.1
Japan / $6.9
Thailand / $6.3
Mexico / $6.1
Poland / $4.9
Portugal / $4.7
Sri Lanka / $3.5
Australia / $3.4
Morocco / $3.2
Canada / $2.9
Egypt / $2.8
Switzerland / $2.7
Source: Global Trade Atlas (GTIS)