INTERNATIONAL TRADE AND REGULATORY ADVISORY

INTERNATIONAL TRADE AND REGULATORY ADVISORY February 6, 2004 USTR RELEASES CAFTA TEXT On January 29, 2004, the Office of the United States Trade Rep...
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INTERNATIONAL TRADE AND REGULATORY ADVISORY

February 6, 2004

USTR RELEASES CAFTA TEXT On January 29, 2004, the Office of the United States Trade Representative (USTR) published on its Web site, at http://www.ustr.gov, the draft text of the Central American Free Trade Agreement (CAFTA). The CAFTA parties are Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the United States. CAFTA will give immediate duty free treatment to many goods, while tariffs on other goods will be eliminated in stages. This advisory summarizes key CAFTA terms.

EFFECTIVE DATE The CAFTA text says the effective date is January 1, 2005. The textile and apparel provisions, however, state that they are effective as of January 1, 2004, indicating that they will be retroactive to that date. The tariff preference level (TPL) for certain apparel from Nicaragua, the special wool apparel provision for Costa Rica, and textile and apparel “cumulation” rules will be effective after CAFTA’s “date of entry into force” and will therefore not be retroactive. Passage of this or any trade-related measure in this Presidential election year may be difficult. While CAFTA could be presented to the U.S. Congress in 2004, the Government may wait until 2005, delaying the effective date.

CAFTA TRADE IN GOODS PROVISIONS Tariff Elimination Some goods will immediately become duty free, while tariffs on other goods will be reduced in annual increments until they are eliminated in accordance with “staging categories.” The staging categories range in time from five years to 20 years. To be eligible for elimination of tariffs, goods must be “originating” under CAFTA’s rules of origin. Rules of Origin Goods qualify as originating if (1) they are wholly obtained or produced entirely in CAFTA countries; (2) any non-originating materials used to produce such goods undergo the required tariff shift due to production in CAFTA countries and the goods satisfy any applicable regional value content requirement; or (3) the goods are produced entirely in CAFTA countries from originating materials. These are similar to NAFTA’s origin rules. www.alston.com

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Regional value content, where applicable, is calculated as a percentage of adjusted value, which is defined generally to mean the customs entered value under the WTO Customs Valuation Agreement. This differs slightly from the methods used under NAFTA, although CAFTA retains the net cost method for automotive products. For most goods, CAFTA allows the presence of de minimis foreign materials that would otherwise be required to undergo the applicable tariff shift. The allowable de minimis is ten percent of the good’s adjusted value (or ten percent by weight of the component determining classification in the case of textiles and apparel). This is more generous than NAFTA’s seven percent. Sets of articles put up for retail sale, which are usually classified as though they consist of the single article that gives the set its “essential character,” will not be considered to be originating unless each component of the set is originating, or unless the value of all non-originating goods does not exceed 15 percent (ten percent in the case of textiles and apparel) of the value of the set. The CAFTA parties can require certificates of CAFTA origin. Goods imported under CAFTA are subject to record-keeping rules, and the customs authorities of the CAFTA countries are empowered to conduct origin verifications in other CAFTA countries. Dealer Licensing CAFTA countries will not require contractual relationships between exporters in other CAFTA countries and local dealers before allowing imports. Also, they will not prohibit imports from other CAFTA countries as punishment for violation of rules governing relationships between local dealers and foreign exporters. Agricultural Goods Tariffs are eliminated over time under staging categories, but tariff rate quotas (TRQs) will continue on many agricultural goods. The parties note that they “share the objective” of eliminating export subsidies through the WTO, but CAFTA nonetheless permits agricultural subsidies as long as a party claims the subsidy is to counter trade distorting effects of third party exports. CAFTA also permits agricultural safeguards that last until the end of the calendar year in which they are implemented, or during tariff elimination or transition periods. The amount of the safeguard may be up to the MFN rate for the first five years, with exceptions for higher tariffs for up to fifteen years for certain dairy products, and fourteen years for certain poultry and rice. Sugar was a sensitive commodity for U.S. negotiators. Thus, in addition to the TRQ on sugar, starting at 99,000 metric tons for the first year and increasing to approximately 140,000 metric tons over 15 years, CAFTA includes a “Sugar Compensation Mechanism.” Under this provision, the United States can make payments to the exporters of sugar instead of permitting duty-free imports. 2

Miscellaneous Goods Provisions •

Non-Tariff Measures: Unless specifically listed, all non-tariff barriers must be consistent with Article XI of GATT.



Temporary Admission of Goods: Entry must be duty free for professional equipment; goods for display or demonstration samples and advertising materials; and goods imported for sports purposes. A Good transferred between CAFTA countries for repair must also be given duty free entry into the country of repair and re-entry into the country from which it was exported for repair. No bond may be required for such repair entries. Commercial samples and printed advertising materials must be admitted duty free.



Distinct Products: No product labeled “Bourbon Whiskey” or “Tennessee Whiskey” may be sold to a party unless it was manufactured in the United States under specified conditions. The Committee on Trade in Goods may, at the request of a party, consider designating other goods as similarly distinct products.



Drawback, Duty Deferral, and Free Trade Zones: Unlike NAFTA, CAFTA does not appear to impose any limit on duty deferral programs ( e.g., bonded manufacturing warehouses and manufacturing temporary importation bonds) or drawback. Free trade zone benefits will continue until 2009.

Safeguards Against Goods Safeguards are permissible if imports increase to an extent that causes or threatens “serious injury” to a domestic industry. Except for agricultural and textile safeguards, discussed elsewhere in this advisory, safeguards allow a duty increase up to the MFN rate, generally for up to four years, but not past the end of a transition period, and concessions must be granted. A safeguard may only be imposed once on the same good. A country must institute a safeguard equally against all parties, unless the imposing country had accorded duty-free treatment to the affected good from a party for three years prior to the effective date of CAFTA, or unless imports from a party are relatively insignificant under certain percentage tests. Parties may not impose safeguards in combination with safeguards permitted under GATT.

TEXTILES, APPAREL, AND FOOTWEAR Elimination of Quotas and Duty on Textiles and Apparel The United States agreed under CAFTA to eliminate its current absolute quotas on textiles and apparel from Costa Rica, El Salvador, and Guatemala, whether or not such articles qualify for duty free treatment under CAFTA’s origin rules. All textile and apparel goods will be immediately duty free from all CAFTA countries if they satisfy CAFTA’s preferential rules of origin. 3

Textile and Apparel Rules of Origin 1. Yarn Forward and Other Tariff Shift Rules No textile or apparel goods are subject to regional value requirements. All of the origin rules applicable to textiles and apparel are tariff shift rules. The most common is the “yarn forward” rule that first appeared in NAFTA. Yarn forward basically means that every process from the formation of the yarn through the completion of the article must occur in one or more of the CAFTA countries. For example, in the case of a cut and sewn apparel article subject to a yarn forward tariff shift, the yarn must be spun or extruded in CAFTA countries, the fabric must be woven or knitted in CAFTA countries, and the garment must be cut and sewn in CAFTA countries. Following NAFTA’s example, CAFTA provides that garments of yarns and fabrics not generally produced in CAFTA countries, such as garments of silk or linen, are subject to a more lenient “cut and sew” rule, under which they are treated as originating goods if they are cut and sewn in CAFTA countries from fabric and yarn of any origin. Brassieres of any fabric are similarly subject to a cut and sew origin rule. This is also identical with treatment of brassieres under NAFTA, and is simpler to use than the complicated brassiere rule under the Caribbean Basin Trade Partnership Act (CBTPA). CAFTA diverges from NAFTA in its treatment of several textile and apparel articles. For example, wool apparel and other articles of wool are originating under CAFTA if they are “fabric forward,” meaning that the yarn can be of any origin. CAFTA also allows a cut and sew origin rule for men’s and boys’ woven boxer shorts and woven pajamas. Another example is man-made fiber sweaters, for which CAFTA applies a yarn forward rule instead of NAFTA’s strict fiber forward rule. Also subject to a cut and sew origin rule under CAFTA are women’s and girls’ woven pajamas and negligees, certain woven girls’ dresses, and certain textile luggage. 2. Application of Tariff Shift Rules For apparel and other made up articles of Harmonized System (HS) Chapters 61, 62, and 63, tariff shift rules only apply to the component that determines the classification of the good. For apparel, this is usually the fabric component that gives the garment its “essential character,” which is most often the fabric forming a garment’s outer shell. Incidental fabric in the garment, like pocketing, is therefore not subject to the applicable tariff shift rule. This exception eliminates the need for a “findings and trimmings” rule like the one found in the CBTPA. However, for many garments with visible linings, a separate rule requires that the visible lining must be woven or knitted in one or more of the CAFTA countries. 4

3. Sewing Thread and Elastic Fabric For all apparel and made up articles of Chapters 61, 62, and 63 containing cotton or man-made fiber sewing thread, the sewing thread must be wholly formed in CAFTA countries. This is the case even for garments, like brassieres, silk apparel, or wool apparel, that are otherwise subject to relatively lenient tariff shift rules. Likewise, for any garment, except brassieres, containing certain woven or knitted elastic fabric of five percent or more elastomeric yarn, such fabric must be wholly formed in CAFTA countries. 4. De Minimis Generally, up to ten percent by weight of non-originating fibers or yarns in goods classified as textile and apparel articles can be non-originating without causing the finished article to lose its originating status. For apparel and certain made up articles containing more than one component, the de minimis allowance is ten percent by weight of the component determining classification. As an exception to the de minimis allowance, CAFTA provides that a good containing elastomeric yarns (except latex) will not be originating unless all elastomeric yarn in the component determining classification is originating. 5. Short Supply Forty-three yarns and fabrics are designated as short supply materials that are not commercially available in the CAFTA countries. The list is a composite that includes all of the yarns and fabrics designated as such in NAFTA, plus additional yarns and fabrics designated as commercially unavailable at the request of petitioners in accordance with procedures for such designations established under the African Growth and Opportunity Act (AGOA), the Andean Trade Partnership and Drug Eradication Act (ATPDEA), and the CBTPA. Any new determinations under AGOA, ATPDEA, or CBTPA made before CAFTA goes into effect will automatically be incorporated in CAFTA. CAFTA also provides for the designation of new short supply articles at the request of interested entities. Such requests will be approved upon a finding that such materials are not available in commercial quantities in a timely manner in any of the CAFTA parties, or in the absence of any objection from other interested entities. Textile articles of Chapters 50 through 60 of the tariff schedule (which include yarns and fabrics) will be treated as originating if they are wholly formed (or meet the de minimis allowance if not wholly formed) in CAFTA countries from any combination of short supply fibers and yarns and originating fibers and yarns. Articles of the remaining Chapters 61 through 63 (which cover apparel and certain made up articles) will be treated as originating if they are cut and 5

sewn or otherwise assembled in CAFTA countries, and if the fabric of the outer shell (exclusive of collars and cuffs) is wholly of one or more of the following: •

short supply fabric,



fabric that is formed in CAFTA countries with short supply yarns,



fabrics that would be considered originating, whether or not they include yarns that meet the de minimis rules.

Nicaragua TPL, Costa Rica Wool Provision, and Cumulation Nicaragua has the only TPL benefit. Costa Rica has a special allowance for certain wool garments. Cumulation is permitted for Mexican and Canadian components in a limited number of apparel items. Nicaragua was granted a very broad TPL for certain non-originating apparel goods of cotton and man-made fibers. If the goods meet all other preferential treatment requirements in CAFTA, and are “both cut or knit to shape, and sewn or otherwise assembled” in Nicaragua, then they are treated as though they are originating if the apparel is made from fabric or yarn “produced or obtained outside the territory of the Parties.” Goods made of wool, silk, and other non-cotton vegetable fibers are excluded. (In the case of garments of silk and other non-cotton vegetable fibers, no TPL was necessary, because CAFTA’s general rules of origin for such garments are already cut and sew rules allowing fabric of any origin.) No wool products are permitted under the TPL. The limit on imports into the United States from Nicaragua under this TPL, during each of the first five years after CAFTA takes effect, is 100 million square meter equivalents (SME). That limit decreases by 20 million SME annually over the next four years. Curiously, the literal language of the Nicaragua TPL appears to prohibit the use of any U.S. fabric in qualifying garments. This prohibition was probably unintentional and could be changed in the final text. Costa Rica was granted a special allowance for certain wool garments and garments subject to wool restraints. These apparel articles are not eligible for duty free import into the United States; they are eligible instead for import at 50 percent of the general U.S. duty rates. As with garments under the TPL for Nicaragua, the wool garments from Costa Rica must be “both cut and sewn or otherwise assembled” in Costa Rica and must satisfy three further requirements. First, the garments must satisfy any applicable rule for visible lining fabrics. Second, for garments containing certain woven or knitted elastic fabric of five percent or more elastomeric yarn, such fabric must be wholly formed in CAFTA countries. Third, any cotton or man-made fiber sewing thread that is incorporated into a covered garment must be thread wholly formed in CAFTA countries. The preferential 6

treatment is limited to imports into the United States of 500,000 SME annually for the first two years. The United States and Costa Rica have agreed to meet six months before the end of that period to determine whether to extend or eliminate the special allowance. Finally, cumulation is allowed for Chapter 62 woven garments containing materials produced in Canada or Mexico, if the Canadian or Mexican components would qualify as originating if they had been produced in a CAFTA country. Two limits apply. First, not more than 100 million SME of cumulated garments may be imported into the United States during the first year after CAFTA takes effect. This limit will be reduced proportionately if CAFTA takes effect after January 1 of any year and may increase to 200 million SME after the first year. Second, within the overall limit, CAFTA creates sublimits of 45 million SME of certain cotton or man-made fiber trousers or skirts, excluding blue denim garments, 20 million SME for certain blue denim garments, and one million SME for certain wool apparel. These sublimits do not increase after the first year. It should be noted that the cumulation rules cannot be effective until the participating countries make necessary changes to their laws and reach certain agreements, which could delay the effectiveness of cumulation until sometime after the effective date of CAFTA. Miscellaneous Textile and Apparel Rules CAFTA provides an alternative rule for apparel and made up articles of Chapters 61, 62, and 63 by which the United States will apply duty only to the value of an assembled good minus the value of the fabrics wholly formed in the United States or components knit to shape in the United States. Such goods must be sewn or otherwise assembled in CAFTA countries with thread wholly formed in the United States from fabric wholly formed in the United States and cut in CAFTA countries or knit to shape in the United States. Yarn in such garments can be of any origin. For sets to be originating, each good in the set must be an originating good, or the value of the non-originating components must not be more than ten percent of the value of the set. CAFTA incorporates a feature of the ATPDEA under which the presence of nylon filament yarns originating in Canada, Israel, or Mexico will not disqualify a textile or apparel good that is otherwise eligible for CAFTA preferential treatment. As in the case of safeguards against other goods, safeguard measures in the form of duties are allowed by any CAFTA country if textile or apparel imports increase to a level that threatens or causes “serious damage” to domestic industry. Safeguards may not last more than three years or past the end of the “transition period,” which is defined as five years after the entry into force of the agreement. Safeguards must be accompanied by concessions.

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Footwear Duty on 17 classifications of originating footwear will be reduced in stages over ten years. All other footwear will immediately be duty free. The 17 classifications with the less favorable duty treatment are generally recognized as classifications of footwear still in fairly substantial production in the United States. These classifications mostly include waterproof shoes and boots containing rubber and plastics. Forty-nine classifications of footwear (including the 17 classifications subject to ten-year staging) will be the subject of a rule of origin modeled after NAFTA’s footwear origin rule. This origin rule requires that uppers used in the shoes must be originating. In addition, these classifications will be subject to a 55 percent regional value content requirement. Negotiators reportedly intended to impose this more stringent rule only on the 17 classifications subject to 10 year staging, but opted to include 49 classifications in order to avoid the drafting complexity that such limited coverage would have required. All remaining classifications of shoes will be subject to a more lenient “single transformation” rule of origin, allowing the use of non-originating components, including uppers. These classifications will also be free of any regional value content requirement. Proposed legislation in the U.S. Congress would, separately from CAFTA, provide duty free treatment for all footwear from beneficiary countries under the Caribbean Basin Economic Recovery Act, other than the 17 categories recognized as still in U.S. production, and would afford such treatment based on a single transformation rule and a regional value content. Interestingly, the CAFTA footwear origin rules specifically provide that importers may claim preference for footwear under any other preferential rule adopted by the United States. This provision appears to anticipate the passage of the pending U.S. legislation.

INVESTMENT, TRADE IN SERVICES, AND OTHER PROVISIONS Customs Administration and Trade Facilitation Each country will publish its customs laws and procedures. The United States will publish them immediately on the Internet, and the other CAFTA countries will do so within two years. The CAFTA countries will also “endeavor” to allow electronic submissions and to use international standards where possible. The Central American parties have three years to comply with these obligations. Each party’s customs authority will also issue advance rulings upon request. The Central American parties have two years to begin issuing such rulings. Labor and Environment CAFTA includes individual chapters on many of the sensitive topics that stalled the Doha Round WTO negotiations in Cancun last fall, although provisions for some areas are lacking in substance or true obligation. CAFTA’s labor chapter notes only that the 8

parties reaffirm their International Labor Organization (ILO) obligations, but that they recognize their right to establish their own domestic labor standards. Hence, they agree to enforce their own labor laws, to provide interested persons with access to tribunals for enforcement of labor laws, and to establish a Labor Affairs Council to address sensitive labor issues, such as child labor, inspection systems, and working conditions. Environmental provisions are likewise vague, allowing countries to set their own environmental standards as long as they enforce them and provide access to tribunals in CAFTA countries. CAFTA also establishes an Environmental Affairs Council, and the parties negotiated a separate United States-Central American Environmental Cooperation Agreement (ECA) to allow cooperation in dealing with certain specific priorities listed in the CAFTA text. The CAFTA environmental provisions resemble those in NAFTA, although CAFTA allows citizens and environmental groups to make complaints against CAFTA countries that fail to enforce environmental laws, and complaints submitted by a party must be entertained even if only one party complains. The parties will establish a committee on Sanitary and Phytosanitary (SPS) Measures, affirm their existing rights under the WTO Agreement on SPS Measures, and state that dispute settlement procedures in CAFTA do not apply to SPS issues. Government Procurement The government procurement rules impose concrete obligations on the parties. They prohibit offsets, require open tendering procedures, and require that each party must grant to all other parties treatment “no less favorable” than it affords its own goods, services, and suppliers. CAFTA prohibits the adoption of technical specifications to create obstacles to trade, and it requires that parties allow suppliers from other CAFTA countries to apply for any registration or qualification standards necessary for award of government contracts. The rules apply generally to all government contracts above certain threshold monetary levels, but not to government assistance programs, purchases funded by loans from international organizations, and certain other situations. There are also familiar GATT exceptions, such as protection of public morals or safety, protection of human, animal, or plant life, protection of intellectual property, provision of services to the handicapped, and prison labor. Additionally, each country has a schedule of particular exceptions; for example, procurement by some states in the United States of “construction-grade steel” is excepted from the government procurement rules. There is also a two-year transition period for compliance by the Central American countries with certain administrative requirements and tendering procedures.

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Technical Barriers to Trade and Transparency CAFTA affirms existing rights and obligations of the parties under the WTO Agreement on Technical Barriers to Trade (TBT Agreement), but for the most part, the parties agree only to “intensify their joint work” in the area of trade facilitation, “with a view to facilitating market access.” The provisions do, however, include a transparency principle requiring the parties to allow other parties “to participate in the development” of “standards, technical regulations, and conformity assessment procedures” on “terms no less favorable than those accorded to its own persons and those accorded to persons of any other Party.” In a separate chapter devoted entirely to transparency issues, part of which simply reiterates the transparency goals stated in other chapters, one notable provision emerges. The parties agree to criminalize, via their own legal systems, bribery of public officials, or acceptance of bribes by officials, in matters relating to international trade and investment. In countries where criminal liability for enterprises does not exist, monetary civil sanctions must be provided. Investment and Services With respect to investment, cross-border trade in services, and financial services, the parties agree to afford both national treatment and MFN treatment. Expropriation by a CAFTA country of the investments of nationals of other CAFTA countries is permissible only if the action is for a public purpose, is applied non-discriminatorily, and is accompanied by compensation. For investment disputes, claimants may resort to a binding arbitration process and the parties must submit to such arbitration. With respect to cross-border trade in services and financial services, the parties may not limit market access via restrictions on the number of service providers or the amount of services provided in an area. Domestic regulations must be based on objective criteria, must not be more burdensome than necessary, and may not impose licensing requirements that are a disguised restriction on market access. Pre-existing non-conforming government measures are excepted. Regarding insurance, CAFTA acknowledges that new legislation must be adopted before Central American countries can comply, and that prior approval is required for new insurance products in certain countries. Costa Rica also negotiated a separate annex for its commitments on insurance services, through which it has agreed to “gradual market access opening commitments.” The chapter on telecommunications assures enterprises in CAFTA countries that they will have access to public telecommunications services. There are also limited provisions for interconnection with services in other CAFTA countries, number portability, and prohibition of anti-competitive practices. The telecommunication regulatory body in a country must be independent of the telecommunication suppliers. Costa Rica has 10

its own schedule of telecommunication service commitments, which gradually implements Costa Rica’s obligation to allow telecommunications providers in party countries to compete in Costa Rica along a timeline lasting until January 1, 2007. Costa Rica is required to establish an independent regulatory agency, provide intercommunication, and implement other requirements similar to those in the main chapter provisions of CAFTA. This separate schedule presumably was necessary because of Costa Rica’s assertion that privatization of its telecommunications industry would violate its constitution. Technology and Intellectual Property CAFTA includes a very short chapter on electronic commerce in which the parties agree not to impose duties on digital products, such as computer programs and sound recordings, imported or exported by electronic transmission, and to afford what is essentially national treatment to digital products of other CAFTA countries. The chapter on intellectual property rights (IPR) states that it contains only the minimum IPR requirements for CAFTA countries and permits countries to adopt stricter rules. The parties must ratify or accede to certain international agreements on IPR by January 1, 2008, and they must provide certain basic rights for trademarks, geographical indications, Internet domain names, copyrights and related rights, such as performance rights, encrypted program-carrying satellite signals, patents, and regulated products including pharmaceuticals and agricultural chemicals. The chapter also covers enforcement of IPR, and it requires that the countries provide rights holders with civil judicial procedures to enforce their rights within existing judicial systems. Tribunals must issue final decisions in writing and have authority to order remedies such as payment of damages or destruction of counterfeit goods. Criminal remedies must be available at least for “willful trademark counterfeiting or copyright or related rights piracy on a commercial scale.” Administrative Issues CAFTA establishes a Free Trade Commission and a Committee on Trade Capacity Building. The agreement also details the dispute settlement mechanism to be used by the parties when they disagree about CAFTA provisions. The process begins with consultations and parties may then request establishment of an arbitral panel, which will issue findings of fact, a determination, and recommendations. If the panel finds a non-conformity with CAFTA, and the parties cannot agree on a resolution, the complaining party may suspend against the other party “benefits of equivalent effect.” The rules differ for labor and environmental disputes. Private rights of action against any party based on CAFTA violations are not permitted. Parties may also be able to resort to the dispute settlement mechanisms if they believe they are being denied, via a measure that otherwise complies with CAFTA, a benefit they should receive under the chapters dealing with national treatment and market access, rules of origin, customs 11

administration, TBT, governmental procurement, cross-border trade in services, or IPR . We are available for consultation on the interpretation and implication of terms in this draft text.

This International Trade and Regulatory Advisory is published by Alston & Bird (www.alston.com) to provide a summary of significant developments to our clients and friends. It is intended to be informational and does not constitute legal advice regarding any specific situation. The material may also be considered advertising under the applicable court rules. If you have any questions or would like additional information please contact your Alston & Bird attorney or any of the following: Jonathan M. Fee 202-756-3387 [email protected]

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Thomas M. Boyd 202-756-3372 [email protected]

Robert W. Irish 202-756-3446 [email protected]

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