The provisions of the North American Free Trade Agreement (hereinafter "NAFTA") between Mexico, Canada, and the United States (hereinafter the "Parties") were adopted by the United States with the enactment of the North American Free Trade Agreement Implementation Act (hereinafter the "Act"). The NAFTA entered into force on January 1, 1994. The stated objectives of the NAFTA included substantially increasing investment opportunities in the territories of the Parties. Without doubt, Mexico has benefitted from increased substantial foreign investment, and trade statistics reveal a marked increase in trade between Mexico and the U.S. since January 1, 1994.

Contrary to what many people think, the NAFTA did not immediately eliminate all customs duties paid on merchandise transported between the Parties. Over a transition period of up to 15 years, NAFTA will eliminate all tariffs on goods originating in Canada, Mexico, and the United States. Furthermore, the tariff schedule of reductions under the U.S. - Canadian Free Trade Agreement have remained intact, yet the NAFTA rules of origin will be used to determine eligibility.

Section 202(q) of the Act authorizes the President, subject to consultation and layover requirements of section 103 of the Act, to proclaim modifications to the rules as may from time to time be agreed to by the NAFTA countries. One of the requirements set out in section 103 of the Act is that the President obtain advice regarding any proposed modification in the Rules contained in Annex 401 of the Act from the United States International Trade Commission (hereinafter "ITC"). In practice, the United States Trade Representative (hereinafter "USTR") requests the advice from the ITC, and the ITC then institutes an investigation. The ITC investigation to the proposed modifications to Annex 401 was completed in September 1995.

Since the enactment of NAFTA, many companies have been going through the process of determining whether their products qualify as "originating goods" under the NAFTA. To do so, companies must apply the rules of origin provision of Chapter Four of the NAFTA and the specific rules of origin set forth in Annex 401 of the NAFTA. The Annex 401 rules change annually, with the date of the last changes effective January 1, 1996. Therefore, any company considering to "qualify" its merchandise must apply the current rules in order to accurately comply with the NAFTA. A company concerned with complying with NAFTA must be alert to changes, however minor, in Annex 401, even if the changes are only made public a few weeks before the effective date, as occurred with the most recent changes which were accessible in the Federal Register on December 15, 1995. Perhaps the Federal Government believes that all companies using the benefits of NAFTA read the Federal Register daily (or even know what it is).

In order to determine what goods are eligible for tariff preferential treatment, rules of origin are necessary. The rules of origin specify that goods originate in North America if they are wholly North American. This means that the goods must be made completely from materials that have been grown or mined in the three signatory countries. Goods which contain non-regional materials can also be considered originating if the non-regional materials are substantially transformed in the NAFTA region by undergoing a specified change in tariff classification. Annex 401 states exactly what the tariff shift must be when the non-regional product undergoes a substantial transformation.

Article 401(b) of the NAFTA provides that a good shall originate in the territory of a Party where: each of the non-originating materials used in the production of the good undergoes an applicable change in tariff classification set out in Annex 401 as a result of production occurring entirely in the territory of one or more of the Parties, or the good otherwise satisfies the applicable requirements of that Annex where no change in tariff classification is required, and the good satisfies all other applicable requirements of this Chapter.

Chapter Four of the NAFTA sets forth the rules for determining whether an imported good qualifies as an originating good of the United States, Canada, or Mexico, and, as such, is therefore eligible for preferential tariff (duty-free or reduced duty) treatment as provided for under Article 302(2) and Annex 302.2 of the NAFTA. Under Article 401 within that Chapter, originating goods may be grouped into two broad categories: (1) produced entirely in one or more NAFTA countries: and (2) goods which are produced entirely in one or more NAFTA countries exclusively from materials that originate in those countries, or goods which are produced entirely in those countries and which satisfy the specific rules of origin in NAFTA Annex 401 (change in tariff classification requirement and/or regional value-content requirement).

Section 4 sets forth the basic rules of origin established in Chapter Four of the NAFTA. Section 4(1) lists those goods which are originating goods because they are wholly obtained or produced in one or more of the NAFTA countries. Section 4(3) provides that goods, produced entirely in the NAFTA countries from originating materials, are originating goods. For most other goods, section 4(2)(a) through (c) sets forth the basic rules of origin for goods which are produced with any non-originating material content.

Essential to these rules in section 4(2) are the specific rules of General Note 12(t), Harmonized Tariff Schedules of the United States (hereinafter "HTSUS"), which are incorporated by reference in Schedule I of the Appendix. Under paragraph (a) of Section 4(2), a good will qualify as an originating good only if all non- originating materials used in the production of the good undergo the applicable change in tariff classification, set forth in General Note 12(t), as a result of processing performed entirely in the NAFTA countries. For certain cases as specified by the rules in General note 12(t), the provision in section 4(2)(b) requires that a regional value content requirement must be satisfied in addition to a change in tariff classification, and other cases only require that a regional value content requirement be satisfied.

Section 181.131 of the Customs Regulations provides that the implementing regulations regarding the rules of origin provisions of HTSUS General Note 12 and NAFTA Chapter Four are contained in the Appendix to Part 181 of the Customs Regulations (19 CFR Part 181 App.). There are surprisingly few requests for a binding ruling from U.S. importers to the Commercial Rulings Division of the U.S. Customs Service. The most common such question would be whether the item produced in a NAFTA country qualifies for preferential duty treatment under NAFTA. The regulations of the Customs Service to request an advance ruling are provided in Part 181. Such a procedure may be used for more complex questions such as whether costs related to the production of the good (e.g. R&D, engineering, U.S. personnel visiting or working in the producer's plant) produced in Mexico are properly included in the calculation of total costs in determining the regional value content of the good under the net cost method. Before submitting a NAFTA Certificate of Origin, it is almost always advisable to obtain an advance, binding ruling from Customs.

An importer who makes a claim for preferential tariff treatment for an originating good must possess a valid NAFTA Certificate of Origin. An importer may make a claim for preferential treatment for an originating good for up to one year after the date on which the good was imported and obtain a refund of excess duties paid. See 19 CFR 181.31. U.S. importers are also required to correct claims if they discover that a Certificate of Origin on which a declaration was based contained incorrect information. See 19 CFR 181.21. Hence, if an importer mistakenly believed that his merchandise qualified as an originating good under the NAFTA, but subsequently discovered that Chapter Four of the NAFTA and Annex 401 of the NAFTA do not, or no longer, allows for such preferential duty treatment, the importer should immediately correct the entry submitted to the customs service of the importing country.

The important thing for a NAFTA exporter or importer to remember is to verify that the current Annex 401 rules that apply to your product legitimately provides that the good originate. We recommend that a company buying or selling products to a Party check with publishers of international trade materials to determine that the company has the 1996 version of Annex 401. If Customs discovers that a Certificate of Origin is incorrect (even if you argue it was based on a 1995 version of Annex 401), Customs may demand substantial monetary penalties for such violations. According to officials at the ITC, companies can expect at least further technical changes in Annex 401 for 1997.