The USMCA – More than A Trade Agreement, A Competitive Strategy: Four Big Questions

Now approaching the start of its fourth year, the USMCA represents a powerful way for companies in this space to maximize access to the United States in a highly competitive global market, as long as they can navigate the pitfalls and challenges. 

Four Big Questions

1. How will the United States respond to the Auto Rules of Origin panel decision?

AFS Forecast: It’s too early to tell, but it seems unlikely that the US will merely accept the decision without further negotiation or challenge.

On January 11, 2023, a USMCA panel ruled in favor of Mexico and Canada, finding that the US was in breach of the agreement by adopting a stricter interpretation of the auto rules, which would have made it more difficult for producers to meet the agreement’s higher regional value content (RVC) thresholds. 

The question now is how the US will respond. Some industry analysts are doubtful whether the US will now change course and follow the Mexican and Canadian interpretation, which allows more foreign content in a vehicle’s core parts to “roll up” as originating. Under this interpretation, an EV built in North America could incorporate more foreign origin parts and still benefit from duty-free treatment under the USMCA.

While the USMCA’s dispute resolution provisions encourage the parties to further negotiate to resolve the dispute, if no resolution occurs, the agreement allows Mexico and Canada to suspend benefits in the same product sector. If previous disputes under the USMCA provide any lessons, it does not appear that this particular dispute, which goes to the heart of the auto rules that were the primary driver behind the US’s renegotiation of the North American Free Trade Agreement (NAFTA), will be resolved any time soon.

2. How will the ITC respond to industry comments on the Auto Rules of Origin?

AFS Forecast: The US International Trade Commission (ITC) report, expected to come out later this spring or early summer, is likely to consider industry feedback in putting out recommendations that could have an impact on any changes to, or interpretations of, the auto rules.

In August of last year, the US International Trade Commission (ITC) launched an investigation into the economic impact of the USMCA auto rules, in the course of which it sought input from the industry. Among other things, the industry commented on difficulties with complying with the labor value content (LVC) requirements, under which either 40% or 45% of the labor that goes into a vehicle must meet a certain average hourly wage rate. The comments also touched upon interpretation challenges raised by the new rules and parts categories under the USMCA auto rules. Overall, the industry stressed the need for a closer dialogue with the US government to address these challenges.

While the aforementioned panel decision could bring clarity to some of these issues, many other concerns remain outstanding. The industry will be watching closely to see how the ITC responds. The ITC report is expected in June 2023.

3. What can the industry expect from CBP in its enforcement of the USMCA?

AFS Forecast: As is typical in the lifecycle of a free trade agreement, the USMCA has matured to the point where the next natural phase would be enforcement, including potential audit activity.

With the three-year transition period nearly complete, the USMCA’s RVC thresholds for qualification will see their final increases for certain vehicles and auto parts starting on July 1, 2023. Along with the release of the panel decision on auto rules, we expect US Customs and Border Protection (CBP) enforcement on the USMCA, and particularly in the auto industry, to continue to increase in the form of audit activity and other enforcement mechanisms. From the agency’s perspective, importers should be well aware by now of their compliance responsibilities.

As part of its enforcement strategy, CBP has been seeking to “baseline” compliance among the automotive industry. CBP is likely to continue its strategy of random targeting of both new and established importers, which may start out with relatively straightforward written questionnaires, but has the potential to lead to a full-blown audit if risks and concerns are identified at the early stages. USMCA enforcement could also open the doors for CBP to “peek under the hood” on an importer’s overall customs compliance, such as valuation and classification. As a result, it is more important than ever for USMCA beneficiaries to make sure their house and supply chains are in order.

4. How will the 2022 tariff classification updates affect USMCA qualification?

AFS Forecast: Because the tariff classification of a product determines which rules apply, the 2022 tariff code updates could have a significant impact on qualification under the USMCA.

The industry has rapidly evolved in the few years since USMCA’s inception, especially with the massive increase in the popularity of EVs. As a result, despite the best intentions of the negotiators, the USMCA is in many ways already struggling to keep up with the major shifts occurring in the auto industry.

CBP regulators are faced with considerable challenges in accounting for the industry’s evolving technology, which appear to outpace USMCA rules and agency rulings. To add to the complexity, in 2022, the Harmonized Tariff Schedule of the United States (HTSUS) underwent a major update, resulting in new tariff codes for products in the EV and auto industry. These HTSUS changes are adding new challenges to interpreting and complying with the USMCA’s auto rules. In some cases, the new HTSUS changes may add complexities to determining whether a certain part is considered a core, principal, or complementary part, which can affect its qualification under the USMCA.

How We Can Help

For many in the EV industry, the consumer EV tax credits offered by the Inflation Reduction Act (IRA) may not be the windfall hoped for due to its onerous North American battery component supply chain requirements. In the coming years, to meet increasing US market demand, EV automakers and suppliers will continue to rely on a global supply chain, importing inputs and finished goods into the US — directly or through third countries. This is where trade programs such as the USMCA can provide significant benefits to companies that are able to take full advantage of them.

The ArentFox Schiff team is monitoring developments in regard to the USMCA closely. Led by former government attorneys from key trade agencies and complemented by a core group of trade professionals, the AFS Electric Mobility team is well-positioned to help your company stay on top of the ever evolving USMCA and trade landscape, and increase your competitive advantage.