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Brexit, trade and rules of origin: A few common misunderstandings demystified

Business goes on as much as possible, despite the COVID-19 pandemic – and one question is how this affects Brexit. While a "Hard Brexit" was avoided when the UK left the EU on 31 January 2020, a common misconception is that nothing has changed, and it's still "business as usual" for UK and EU companies in trade with the rest of the world - at least in the Transition Period, which will apply until the end of this year unless extended. Extension was said to be unthinkable by UK Prime Minister Boris Johnson, but COVID-19 may change that, not least because the Chief negotiators for both the EU and the UK and the UK Prime Minister Boris Johnson are in quarantine (and PM Johnson hospitalised). The negotiations on the future relationship have been significantly affected, in what was already a very challenging timeframe. Business organisations and the European Parliament are calling strongly for an extension of the Transition Period to take account of these exceptional circumstances. We try here to correct some of the common misunderstandings about Brexit which abound.

 

"Nothing has changed in 2020 under the Transition Period"

It is true that no tariffs or customs formalities apply in trade between the UK and the EU during the Transition Period, because they remain in the same customs union. However, the situation is different where EU or UK goods are traded with "third" countries with which the EU has a Free Trade Agreement (FTA). Because the UK is legally no longer a Member State of the EU, EU FTA partner countries legally are not bound by these FTAs as regards the UK.

Under these FTAs, a product can only benefit from tariff preferences if it meets the rules required to "originate" in one of the FTA partner countries. The precise rules differ per product category, but often: (i) a "cap" applies on the use of non-originating materials; (ii) a certain percentage of the product's value has to be sourced/created in the FTA partner countries; or (iii) certain processing must take place in the FTA area. As the UK is no longer an EU Member State, materials sourced in the UK no longer need to be considered as "originating" materials, and UK processing does not constitute "local processing" under the origin rules. Such UK input therefore counts against origin.

As part of the Brexit deal, the EU has asked all its FTA partner countries to treat UK products and input materials as "EU" materials during the Transition Period. That would allow the origin of goods produced in the EU with UK materials (or goods produced in the UK) to remain unaffected for now by Brexit. Nevertheless, UK and EU manufacturing companies should know that some FTA partner countries may decide not to grant this flexibility. If so, an EU product with UK components could be denied tariff preferences at import in an EU-FTA partner country if it no longer satisfies the relevant origin rule. This could directly result in increased duties (and administrative headaches), and in turn could result in claims for damages by their customers to compensate for unexpected import duties, depending on the contract terms for the supply of these goods.

 

"Business as usual will continue with a UK-EU FTA from 2021"

Hopes are pinned on the entry into force of an FTA between the UK and the EU on 1 January 2021, so that there is no gap in duty-free trade between the UK and EU from the end of the Transitional Period until the new FTA regime. Even if an FTA is in place, and there is certainly no guarantee of this, particularly in light of the COVID-19 crisis, tariff preferences will depend on the FTA's preferential origin rules being satisfied. This is not "business as usual" nor a simple continuation of the current position.

In practice, it means extra administration, time and cost for all those exporting between the EU and UK. Depending on the relevant rules of origin and the supply chain, products produced in the UK with inputs sourced from third countries may not meet the rules and will not benefit from tariff preferences when imported into the EU (even if that third country has an FTA with the EU – see below).

In addition, under an FTA, proof of origin has to be available. Although the EU wants to use its model origin rules, and self-declaration of origin would be possible (as opposed to having to apply for a certificate of origin from the customs authorities), this still requires supporting evidence. Currently, on the basis of the EU's draft Comprehensive Partnership Agreement ("CPA") submitted to the UK (dated 18 March), the EU is proposing that claims for preferences are either made on the basis of an origin statement by the exporter or "importer's knowledge" (following the model set out in the EU-Japan FTA). The EU does not seem to envisage setting a value threshold above which approved exporter status is required for self-declaration of origin (often EUR 6000 under EU FTAs), but record-keeping obligations would still have to be satisfied. So, at the very least, there will be a greater administrative burden to evidence originating status in bilateral UK-EU trade, even if the origin rule is satisfied.

 

"55% value added means 55% UK value added under a future EU-UK FTA"

If an origin rule requires at least 55% of the input materials (in value terms) to be "originating", this normally means "originating in one of the FTA partners". This is the "bilateral cumulation of origin" rule which is available under all the EU's FTAs as an incentive for companies to source input materials from within the FTA region in order to enhance trade integration between the FTA partners. The EU's draft CPA text confirms that the EU expects this to be in place. Therefore, a UK manufacturing company would be encouraged to source components in the EU and not just the UK, and vice versa, in order to satisfy the origin rule, but problems may arise when non-UK/EU materials are used.

 

"If both the EU and the UK have an FTA with the same third country, this solves all sourcing problems"

Unfortunately, the complexity of rules of origin means it is not enough for there to be two bilateral agreements between the EU and UK respectively and a third country to solve sourcing problems. A further type of "cumulation" plays an important practical role in supply chain management: "diagonal/regional cumulation". This allows goods originating in certain other countries to be counted as originating and included as inputs in products benefitting from FTA preferential access. The UK has proposed this in its unpublished draft agreement shared with the European Commission in March. However, the EU's draft CPA text reveals that it will not seek diagonal/regional cumulation of origin in its existing or future FTAs with third countries, so that UK input materials would be counted as "originating" materials. This means that in the case of the EU-Japan FTA, Japanese materials used in UK production would not be "originating" materials for duty free entry into the EU. Likewise, for duty free export to Japan from the EU, UK parts would not count as originating for EU manufacturers. This is an important difference from the current position.

In general, regional cumulation would have to be included in each bilateral agreement entered into by the EU and UK respectively with the third country concerned, and that would normally also mean identical productspecific origin rules. This means that if the UK in its own FTA negotiations were to deviate from the origin rules the EU has in place with the same third country, an obstacle would likely be created for regional cumulation. The conclusion is that additional complexity and cost is inevitable for manufacturers with complex supply chains, even if the UK enters into its own agreements with third countries with which the EU has FTAs.

 

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