How does NAFTA apply to federal pacts?

A reader asked the following question: The Federal Acquisition Regulation allows offerors to supply items to the federal government that are "substantially transformed" in Canada or Mexico as provided by the North American Free Trade Agreement. However the regulation does not include any real explanation of what this means. How does NAFTA apply to government contracting?

As presented in the last two Legal Review columns numerous laws establish preferences for the products of certain countries in government contracting. The issue of what constitutes a valid NAFTA-country end product is another illustration of how complex this area can be.

For most purposes including application of import tariffs country-of-origin labeling and related matters the U.S. Customs Service has promulgated formal regulations. Although interim regulations have been in place since NAFTA became effective in 1994 final regulations were not issued until June 1996.

The Customs Service's regulations to implement NAFTA employ a unique concept known as a "tariff shift." NAFTA rules for country-of-origin labeling provide that a product's country of origin is the country in which: (1) the good is wholly obtained or produced (2) the good is produced exclusively from domestic materials or (3) "each foreign material incorporated in that good undergoes an applicable change in tariff classification" based on the Harmonized Tariff System of the United States (HTSUS). For example if a computer is built in Mexico from components that originate in other countries the computer will be considered a product of Mexico only if the computer is classified under a tariff heading different from any component in the computer. This change is called a tariff shift.

The regulations also establish rules for determining the country of origin when the tariff-shift definition is not met. For example if a single component imparts the essential character of the finished item the country of origin for that component may be considered the country of origin for the end product.

Far more subjective is the "substantial transformation" test which underlies most country-of-origin rules including previous Customs Service tariff rules and the Trade Agreements Act (TAA) rules set forth in the FAR. The Customs Service believes that NAFTA rules of origin are consistent with the substantial-transformation test but acknowledges that many people have different views.

For government contracting purposes NAFTA was implemented through an amendment to FAR Part 25. For manufactured goods FAR Part 25 now defines a "NAFTA-country end product" as a product that is substantially transformed in Canada or Mexico. Obviously to the extent that the substantial transformation test might vary from the tariff-shift provisions the acceptability of a Mexican or Canadian product on a government contract can become even harder to analyze. However NAFTA-country end products can have substantial benefits that make this analysis worthwhile.

NAFTA-country end products are entitled to the same treatment as "designated-country end products" for purposes of applying the TAA restrictions. This is important because Mexico is not a designated country under the TAA. Prior to NAFTA an agency could not accept Mexican end products under contracts to which the TAA applied.

Clearly offering a NAFTA-country end product has significant advantages. It can be difficult however to know whether a product qualifies. Anyone thinking of offering Canadian or Mexican end products on a government contract should analyze the regulations carefully before making any commitments.

Peckinpaugh is a member of the government contracts section of the law firm of Winston & Strawn Washington D.C.