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United States Trade Alert: Mexico Requests Consultations With United States Concerning Automotive Rules of Origin Under US-Mexico-Canada Agreement

On August 20, the Government of Mexico requested consultations with the United States under the US-Mexico-Canada Agreement (USMCA) "for the purpose of avoiding or settling a potential dispute" regarding the Agreement's rules of origin ("ROO") for automotive goods. The request alleges that the United States, through its interpretation of the ROO for automotive parts and finished vehicles, is "imposing certain requirements on motor vehicle producers that are inconsistent with the text of the USMCA and the Uniform Regulations." Specifically, Mexico contends that the USMCA's automotive ROO permit the use of "roll-up" methodologies, which allow materials that have acquired origin by meeting a regional value content (RVC) threshold to be considered fully originating when used as inputs in a subsequent manufactured product (e.g., a finished vehicle). Such methodologies provide additional flexibility for producers of finished goods to satisfy the applicable ROO and therefore obtain preferential tariff treatment. However, the United States has taken the position that the USMCA provisions at issue do not permit the use of roll-up methodologies – a position consistent with its objective to limit the use of foreign content in the North American automotive supply chain. 

The United States and Mexico have held informal consultations on this issue at the political and technical levels, but have failed to reach a consensus interpretation. Mexico is now requesting formal consultations under the USMCA's state-to-state dispute settlement mechanism to resolve the matter. If the two governments are unable to resolve the matter through formal consultations, an independent panel will convene in accordance with Chapter 31 of the USMCA to hear the dispute and potentially authorize the imposition of countermeasures, in the event that a violation is found. This alert provides an overview of the relevant USMCA provisions, Mexico's request for consultations, and the next steps in the dispute settlement process. 

 

Background

Like the NAFTA, the USMCA provides that finished vehicles and parts thereof must contain a specified level of regional value content to be considered "originating" for purposes of the Agreement. Only originating vehicles and parts are eligible for duty-free treatment under the USMCA. The ROO for passenger vehicles, light trucks, and parts thereof are set forth in Article 3 of the Appendix to Annex 4-B of the USMCA (Automotive Appendix). As discussed in greater detail below, Article 3 provides separate ROO for vehicles and several distinct categories of parts, namely "core" parts (and groupings thereof), "principal" parts, and "complementary" parts. 

RVC for passenger vehicles and light trucks (Article 3.1)

Whereas the NAFTA required that vehicles contain at least 62.5% RVC to be considered originating, the USMCA increases this requirement to 75% for passenger vehicles and light trucks (calculated using the "net cost" method).1This increase is being phased in over a three-year period as follows:

Date

RVC (net cost)

July 1, 2020

66%

July 1, 2021

69%

July 1, 2022

72%

July 1, 2023

75%

RVC for core parts, principal parts, and complementary parts (Articles 3.2-3.5)

Under the USMCA, the RVC requirements for parts for passenger vehicles and light trucks range from 65 to 75% net cost (or 75 to 85% under the "transaction value method"),2 also to be phased in over a three-year period:

  • "Core parts," including engines, bodies, gearboxes, and shock absorbers will be subject to a final RVC threshold of 75% net cost (85% transaction value). 
  • "Principal parts," including tires, mufflers, seats, and ball bearings will be subject to a final RVC threshold of 70% net cost (80% transaction value). 
  • "Complementary parts," including types of valves, batteries, and lamps will be subject to a final RVC threshold of 65% net cost (75% transaction value).

RVC and alternative calculation methodologies for "super-core" parts (Articles 3.7-3.9)

Table A.2 of the Automotive Appendix, reproduced below, identifies in Column 1 certain core parts to which special rules applycOLUMN

Column 1

Column 2

Parts

Components

Engine

Heads, Blocks, Crankshafts, Crankcases, Pistons, Rods, Head subassembly

Transmission

Transmission cases, Torque converters, Torque converter housings, Gears and gear blanks, Clutches, Valve body assembly

Body and Chassis

Major body panels, Secondary panels, Structural panels, Frames

Axle

Axle shafts, Axle housings, Axle hubs, Carriers, Differentials

Suspension System

Shock absorbers, Struts, Control arms, Sway bars, Knuckles, Coil springs, Leaf springs

Steering System

Steering columns, Steering gears/racks, Control units

Advanced Battery

Cells, Modules/arrays, Assembled packs

Article 3.7 of the Automotive Appendix provides that a passenger vehicle or light truck is originating only if the core parts listed in Column 1 above are originating. Generally, such parts are originating if they satisfy the 75% RVC threshold applicable to a "core part" under Article 3.2. However, Articles 3.8 and 3.9 provide certain alternative methodologies that producers may use when determining whether these parts are originating:

  • Article 3.8 provides that, when calculating the RVC of a core part listed in Column 1, producers have the option to base the value of non-originating materials on (1) the value of all non-originating materials used in the production of the part; or (2) the value of any non-originating components that are used in the production of the part and are specifically listed in Column 2 of Table A.2. The latter option limits the universe of inputs that may count as non-originating content when determining the RVC of the core part. 
  • Article 3.9 provides that, instead of calculating the RVC for each of the core parts in Column 1 individually, producers may choose to treat all of the Column 1 parts as a single, "super-core" part for purposes of determining RVC. Where the producer chooses to treat these parts as a single super-core, it must sum the net cost of each part to determine total net cost of the super-core, and may base the value of non-originating materials on: (1) the sum of the value of all non-originating materials used in the production of the parts; or (2) the sum of the value of only those non-originating components (listed in Column 2) that are used in the production of the parts. If the RVC of the single, super-core part satisfies the 75% RVC threshold, "each Party shall provide that all [of the Column 1 parts comprising the super-core] are originating[.]"

Dispute over "roll-up" methodology and implications for RVC calculations

As discussed in more detail below, Mexico's interpretation of the automotive ROO would permit the use of "roll-up" methodologies for core parts listed in Table A.2, thus providing additional flexibility for vehicle producers to satisfy the ROO for finished vehicles. The implications of the roll-up methodology may be illustrated by the following, simplified example:

  • For purposes of calculating the RVC of the core parts in Table A.2, Column 1 (i.e., the engine, transmission, body and chassis, axle, suspension system, steering system, and battery), a vehicle producer chooses to treat such parts as a single "super-core" part in accordance with Article 3.9, rather than calculating RVC for each part individually;
  • The vehicle producer determines that the super-core part, which has a total net cost of $20,000, is originating, because the value of non-originating materials across all of the core parts thereof is only $4,000 (thus satisfying the 75% RVC requirement of Article 3.2);
  • For purposes of determining the RVC of the finished vehicle, the producer treats the entire $20,000 net cost of the super-core part as originating content. That is, rather than subtracting the value of non-originating materials ($4,000) from the net cost of the super-core part, the value of non-originating materials is "rolled up" into the net cost of the super-core part. 

The United States reportedly has advanced a different interpretation of the relevant provisions of the automotive ROO. Under the United States' interpretation, the value of non-originating materials in the super-core part would not be treated as originating for purposes of determining the RVC of the finished vehicle. Rather, only the portion of the super-core part that is originating ($16,000, in the above example) would be counted as originating when determining the RVC of the finished vehicle. This interpretation discourages the use of core parts (and in turn, components thereof) that are deemed to originate outside the USMCA region.

 

Request for Consultations 

Mexico's request for consultations concerns the United States' "application and interpretation" of Article 3 of the Automotive Appendix, as well as Article 4.5.4 of the USMCA, which sets forth general rules concerning RVC calculations under the Agreement. Mexico's request describes its own interpretations of these provisions, focusing primarily on those applicable to core parts:

Articles 3.8 and 3.9 

According to Mexico, the "alternative calculation methodologies" provided for core parts in Articles 3.8 and 3.9 "can be applied in the overall passenger vehicle's or light truck's RVC calculation." 

As noted above, Article 3.8 describes two permissible methodologies for calculating the RVC of the core parts in Table A.2, Column 1. The first methodology requires that the value of non-originating materials be based on the value of all non-originating materials used in the production of the part, whereas the second limits the universe of inputs that may count as non-originating to those components listed in Column 2. Mexico contends that "[t]he use of any of these methodologies is allowed to qualify the core parts as originating, and subsequently, for purposes of calculating the origin of the vehicle" (emphasis added). 

Further, Mexico notes that Article 3.9 "provides an additional flexibility for a ‘super-core part' that allows the calculation of the RVC of all core parts as they were a single auto part." Mexico indicates that the interpretation of this provision should be informed by Article 4.5.4 (Regional Value Content) of the USMCA, which states the following: 

Each Party shall provide that the value of non-originating materials used by the producer in the production of a good shall not, for the purposes of calculating the regional value content of the good under [Article 4.5.2 or 4.5.3], include the value of non-originating materials used to produce originating materials that are subsequently used in the production of the good.

In Mexico's view, Article 4.5.4 means that "once a material ('core-part') has qualified as originating and has been used in the production of a good, it must always be treated in the calculations as originating." Therefore, "if a ‘super-core part' meets the RVC required percentage, all the core parts comprising the 'super-core part' would be originating" (emphasis added). Mexico asserts that the Uniform Regulations adopted by the USMCA Parties "develop and reiterate this principle[.]" Among other provisions, the request cites section 14(1) of the Uniform Regulations, which states in part that "[t]he value of non-originating materials used by the producer in the production of a passenger vehicle, light truck and parts thereof must not, for the purpose of calculating the regional value content of the good, include the value of non-originating materials used to produce originating materials that are subsequently used in the production of the good." 

Article 3.7

Article 3.7 of the Automotive Appendix reads in the relevant part as follows:

Each Party shall provide that a passenger vehicle or light truck is originating only if the parts under Column 1 of Table A.2…used in the production of a passenger vehicle or light truck are originating. Such a part is originating only if it satisfies the regional value content requirement in [Article 3.2], except for an advanced battery.

Mexico interprets this provision as "stipulat[ing] that once the core parts (materials) have satisfied the RVC percentage required in Article 3.2 of the [Appendix], such core parts are originating." Consequently, "for purposes of their use in the production of a subsequent good (vehicle), those core parts would be considered as originating" (emphasis added).

Taken together, Mexico's interpretations of Article 3 of the Automotive Appendix and Article 4.5.4 of the USMCA would permit the use of roll-up methodologies when determining how certain core parts factor into the RVC of a finished vehicle – a position that is at odds with the United States' interpretation.

 

Next steps

The automotive rules of origin were among the most complex and contentious issues addressed in the USMCA negotiation, given the tensions between the United States' goal of promoting domestic production and investment, on the one hand, and the desire of the other Parties to preserve the cost-competitiveness of the North American automotive industry and encourage North American production that results in originating content. The differences in interpretation between the United States and Mexico reflect these divergent priorities, as well as the consistency of the Biden administration's views on automotive trade with that of its predecessor. 

In accordance with Article 31.6 of the USMCA, the two governments will have 75 days to resolve this matter through bilateral consultations, unless they agree on a different time period. If they fail to resolve the matter during the applicable timeframe, Mexico will be permitted to request the establishment of a dispute settlement panel to determine whether the United States' application of the relevant provisions is consistent with the terms of the Agreement. The process of arriving at a panel ruling would involve several procedural steps, including a panel composition process,3 and the issuance of a panel report within prescribed time frames.4 In total, the issuance of a final panel report would likely occur no earlier than 315 days after the date on which the request for consultations was submitted (i.e., on or after July 1, 2022). 

Whether the dispute is resolved through consultations or a formal panel proceeding, it will have important implications for automotive supply chains, though these are likely to vary significantly depending on the individual circumstances of specific producers and suppliers. Importantly, the USMCA's Rules of Procedure allow a Panel to consider written views submitted by non-governmental entities during the course of the dispute, in addition to hearing the views of the disputing Party governments.5 Producers and suppliers throughout the automotive supply chain should examine the implications of the Parties' competing interpretations of the USMCA and consider strategies to protect their commercial interests.

Mexico's request for consultations can be viewed here ›

 

1 Under the net cost method, RVC is calculated by subtracting the value of non-originating materials from the total net cost to produce the vehicle and dividing this figure by the vehicle's total net cost.
2 Under the transaction value method, RVC is calculated by subtracting the value of non-originating materials from the transaction value of the good (i.e., the amount actually paid or payable for the good), and dividing this figure by the transaction value of the good.
3 In disputes involving two Parties, Panels will consist of five members (unless the Parties agree to a panel comprised of three members), selected from a pre-determined roster established by the Parties. The USMCA Parties established the Roster of Panelists for Chapter 31 Dispute Settlement Panels on July 2, 2020. See FTC Decision No. 1, Annex IV (July 2, 2020).
4 The Panel must present an initial report to the disputing Parties no later than 150 days after the date of the appointment of the last panelist, except in "exceptional cases," in which the report may be delayed by an additional 30 days. USMCA Art. 31.17(1)-(2). The 30-day deadline may be altered if the disputing Parties agree. See also USMCA Arts. 31.18 and 31.19. The Panel reports must contain (1) "findings of fact"; (2) determinations as to whether the measure at issue is inconsistent with obligations in the Agreement, or a Party has otherwise failed to carry out its obligations in the Agreement; and (3) recommendations, if the disputing Parties have jointly requested them, for the resolution of the dispute. USMCA Art. 31.13.1.
5 Article 20, USMCA Rules of Procedure for Chapter 31.

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