Free Trade Agreements: A Practical Introduction

What is a Free Trade Agreement?

Free Trade Agreements can be signed between 2 countries or several countries. Free Trade Agreements can also be referred to as treaties. These agreements are designed to make trade activities between member parties easier by various means such as by setting favourable tariff rates, market access conditions and reducing non-tariff barriers to entry between members of the trade pact. The legal text of any trade agreement typically covers many areas of cross border trade facilitation between members governing many areas such as the movement of investments, human resources, intellectual property and government procurement.

Some Major Free Trade Agreements:

  1. North American Free Trade Agreement also known as NAFTA, is an agreement between the United States, Mexico and Canada.
  2. ASEAN Trade in Goods Agreement also known as ATIGA or ASEAN FTA, is a multilateral agreement in force between Indonesia, Malaysia, LAO PDR, Singapore, Vietnam, Thailand, Philippines, Cambodia, Myanmar and Brunei.
  3. U.S – Korea Free Trade Agreement also known as KORUS, is a trade pact signed bilaterally between South Korea and the United States.

How to use a Free Trade Agreement to pay lower or no import duty?

  1. Traders need to check that a signed Free Trade Agreement is in Force between the country of manufacture and the destination country. They have to ensure that they are not trying to use a Free Trade Agreement that is still in negotiation or pending ratification.
  2. The manufacturer in the exporting country needs to then ensure that the products they manufacture qualify for the specific Free Trade Agreement that the importer wants to use.
  3. Qualification assessment for FTAs is typically done by calculating local value content percentages, a tariff shift analysis or a combination of both, although the legal text of the FTA may provide for other methods of assigning country origin status.
    • Local Value Content is sometimes also referred to as Regional Value Content. This means that if the local originating value of the product meets a certain threshold specified in the legal text of the FTA, it can be qualified for duty benefits when imported. Several cost components are taken into consideration to derive the local content of a product, such as indirect costs, raw material costs and FOB price of the product. The legal text of a treaty will provide formulas that usually allow traders to either build up or build down to the regional value content percentage.
    • Tariff shift refers to a change in HS codes of all the foreign raw materials when compared to the HS code of the finished product. The legal text of the FTA will dictate the level of change required. The underlying logic behind this approach is that with a significant change in the HS code between raw materials and final product, the part has undergone significant transformation in the origin country to qualify it with an originating status. The tariff shift rule is sometimes referred to as the Change in Tariff Header (CTH) or Change in Tariff Sub-Header (CTSH) rule.
    • Some treaties allow for de minimis considerations, where foreign material below a specified percentage can be disregarded when assessing the qualifying status of a product.
  4. If the manufacturer is convinced that their product qualifies for the FTA, the manufacturer will then have to meet the exporting country’s administrative requirements before he/she can start applying for Preferential Certificates of Origin on exports. This typically involves the submission of a cost statement showing detailed cost analysis, collection of suppler affidavits and making various other submissions to Customs authorities or Foreign Trade Departments. An on-site inspection may be required before authorities give their approval for the manufacturer to start applying for FTA Forms. In some countries, qualification processes are self-declaration based. It must be mentioned that in almost all cases, the exporter or manufacturer of the product has to do the work of getting the FTA Forms available, while the importer enjoys all the benefits of paying lower or no duties.
  5. Once the manufacturer has the necessary approval, they will be able to apply for the Preferential Certificate of Origin or in the case of some FTAs, will be legally allowed to make self-declarations of FTA qualification status on their invoices.
  6. The importer receiving the cargo will then have to show the documents to Customs authorities in the importing country to enjoy lower or no import duties on their shipments.
  7. It is important that both the exporter and the importer carefully study the overleaf notes on every preferential certificate of origin they handle in order to ensure they are familiar with the terms and requirements of using the agreement. These notes cover a range of formalities such as the information that must be shown on a Form and the available Rules of Origin for use.
  8. Usually the exporter’s rights to apply FTAs on their exports do not last indefinitely and they should be careful to monitor privilege expiry dates and renew them on time if necessary.
  9. It must be noted that some FTAs have conditions of acceptance surrounding cargo that does not arrive directly from origin ports, or they may not accept the use of Free Trade agreements for non-direct shipments at all.

It must be mentioned that in almost all cases, the exporter or manufacturer of the product has to do the work of getting the FTA Forms available, while the importer enjoys all the benefits of paying lower or no duties.

For example, if you intend to apply for an FTA Preferential Certificate of Origin (ATIGA) for products exported from Singapore to a customer in Thailand:

  1. First the manufacturer must register their premises and activity with Singapore Customs. Upon submission of registration documents, Customs may choose to make a site visit to observe processes and inspect financial records.
  2. After successful registration, the manufacturer must submit a manufacturing cost statement in the specific template required by Customs.
  3. If the MCS is approved, the exporter can then apply for FTA forms for their exports through Singapore’s National Single Window, known as TradeNet.
  4. Applications are done individually for every shipment.
  5. After the ATIGA Form D is approved, the exporter will have to collect the original copy from Customs and courier it over to the destination.
  6. Upon receipt of the Form D in destination, the importer will have to present it to Customs in order to avail lower or no duty on shipments.

Differences between Free Trade Agreements:

Not all trade pacts are the same, although chunks of legal text may be similar. When considering the use of a specific agreement, the trader should check the following:

  1. Are the country of manufacture and the destination country both members of the FTA?
  2. Is the FTA already in force?
  3. What are the rules of origin allowed by the FTA?
  4. Does the FTA allow third party invoicing?
  5. Does the FTA allow non-direct shipment routes?
  6. Does the FTA allow retroactive issuance?

Usually, assessing the product for FTA qualification is the most important step, followed by the manufacturer being able to meet all the administrative requirements to start applying for Preferential Certificates of Origin on shipments. It should never be assumed by importers that they will be able to avail FTA benefits as long there is a trade pact existing between their country and the manufacturer’s country. Instead, traders should do a detailed study and test run with pilot shipments before embarking on any new supply network involving the use of trade pacts, before factoring the duty benefit into the costing for margin uplift.

Instead, traders should do a detailed study and test run with pilot shipments before embarking on any new supply network involving the use of trade pacts, before factoring the duty benefit into the cost analysis for margin uplift.

Common issues faced when using Free Trade Agreements:

  1. Wrong format: The information appearing on most Free Trade Agreement Forms must be presented in a specific format. On the application page, not all required data elements will be neatly entered in dedicated free-text boxes and the system may not always prompt the applicant to enter all necessary information. In some cases, Customs systems may even accept and approve incomplete or incorrectly filled in Forms. For example when using ATIGA the exporter must remember to include the manufacturer’s information in Box 7 of the Form.
  2. Wrong HS code: If a tariff shift rule is used for qualification, the correct HS code must be used and presented on the Form for the finished product. A wrong HS code will make the Form invalid. Read our detailed guide to tariff classification here.
  3. Incomplete information: Information should be presented in a complete manner. Product names on Forms should never be abbreviated to an extent that they are unrecognisable when compared to invoice product descriptions. Invoice numbers must be correctly entered for each line item. Some countries require product names on Forms to be an exact match to product names on invoices.
  4. Issued retroactively calculation and tick: If the FTA Form requires the “Issued Retroactively” indicator to be maintained, the number of days of calculation should start from the onboarding date of the shipment. Different FTA’s have different conditions to determine when this box should be ticked.
  5. Missing signatures: Many FTA Forms require 2 signatures – 1 signature belonging to the exporter and the other to the issuing authority. When collecting Forms from issuing agencies, the exporter should carefully check that the authority has signed the Form correctly and remember to sign the Form as well prior to couriering them over to destination.
  6. Making manual amendments: Customs agencies in many countries do not accept FTA Forms that have manual amendments made on them. If any revisions need to be made, traders should cancel or return existing Forms, and have new Forms issued showing the correct information.

References

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