The Impact of Brexit and Origin Rules on Trade between Japan, the UK and the EU

At the end of the Brexit transition period on 31 December 2020, the EU-Japan Economic Partnership Agreement (“EU-Japan EPA”) ceased to apply to trade with the UK.  In anticipation of this change the UK and Japan signed on 23 October 2020 a “roll-over” or continuity trade agreement that largely mirrors the terms of the EU-Japan EPA, called the Comprehensive Economic Partnership (“UK-Japan CEPA”).  This agreement follows the EU-Japan EPA very closely and includes a protocol based on the earlier EU-Japan mutual recognition agreement.  We initially commented on it here.  In this note we comment specifically on how Brexit, these agreements and the EU-UK Trade and Cooperation Agreement (“TCA”) affect the origin rules applicable to Japanese trade with the EU and the UK.

Preferential Rules of Origin

The critical difference between a customs unions and a free trade agreement is that the former creates a uniform customs territory whereas the latter merely removes duties on trade between the parties in their own goods while the parties maintain independent customs regimes towards third countries.  To avoid circumvention of their respective independent customs regimes, the parties to free trade agreements limit the preferential treatment to goods that they consider originate in their respective territories.  For this purpose, such agreements contain detailed rules of origin to determine which goods the parties will accept as originating in their respective territories.  The resulting rules are termed “preferential rules of origin” and are stricter than the normal rules of origin deriving from the Kyoto Convention, administered by the World Customs Organisation that apply to non-preferential trade.  For manufactured goods the typical general rule of origin provides that the good originates in the territory where the last substantial transformation occurred whereas preferential rules of origin often lay down minimum content or value-added requirements.  Thus, for example, in the case of motor vehicles, the preferential rule of origin applied by the EU is that 60% of the value of the vehicle must arise in the territory concerned before the vehicle can be considered to originate there.

If an importer cannot prove that a product satisfies the conditions laid down in preferential rules of origin, the full amount of duty laid down in the WTO GATT Schedules is payable notwithstanding the free trade agreement.  It appears that in many cases importers find the cost and effort of applying for preferential treatment too burdensome.  A recent report of the European Commission revealed that less than half of Canadian import into the EU take advantage of the preferences in the EU-Canada free trade agreement (“CETA)”.  The EU-Japan EPA is too recent for data to have been collected but it may be that there is a similar rate of non-utilisation of tariff preferences.

Cumulation

One facilitation that free trade agreements generally allow is that raw materials and components from the importing country (for instance the EU) which are incorporated into a products in the partner exporting country (for instance the UK) are counted towards satisfying the origin requirements (so-called “bilateral cumulation”).

Some of the EU’s trade agreements with developing countries have also allowed so-called diagonal cumulation whereby raw materials and components from countries with similar agreements are allowed to be counted towards satisfying origin requirements.  Thus, fruit produced in one partner country can be canned in another with sugar from a third and benefit from preferences in the EU as if made entirely from raw materials and components from the country exporting the final canned fruit product.  This furthers the development objectives of these agreements and is sometimes said to promote “South-South trade”.  The same approach to cumulation of origin is not taken in the EU’s trade agreements with developed countries such as Japan. The EU considers that diagonal cumulation is only feasible where all countries have the same preferential rules of origin towards partner countries and agree to administrative cooperation in their application.  Developing countries have generally accepted the EU standard preferential rules of origin but others have their own rules that they apply.

The impact of Brexit

Brexit significantly impacts the use of preferences negotiated between the EU and other countries such as Japan because EU-origin is now restricted to the 27 EU Member States rather than the previous 28 with the UK.  For example, a machine made in Japan incorporating components imported from the UK would have automatically been recognised as of Japanese origin and entitled to the relevant tariff preference when imported into the EU before Brexit but this is no longer the case since 1 January 2021.

Third countries that have concluded free trade agreements with the EU are suffering a sudden loss of the market access that they had anticipated because of the effect of the change on origin in certain supply chains as well as that resulting from the shrinkage of the territory of the EU.  Confronted with objections from negotiating partners, the UK has provided for diagonal cumulation for EU materials in its continuity trade agreements with most countries.  As a result, imports of goods from such a third country that incorporate raw materials or components from the EU and would therefore, before Brexit, have qualified as originating in that third country by virtue of the bilateral cumulation rule, will continue to be benefit from preferential tariff treatment in the UK. These third countries have accorded similar treatment to imports from the UK incorporating EU materials.

This is in particular the case in the UK-Japan CEPA.

Thus a motor vehicle made in the UK incorporating a significant proportion of components imported from the EU will be treated by Japan as entitled to the tariff preferences in Japan. The UK will give similar treatment to motor vehicles from Japan made largely from components imported from the EU.

Japanese components in UK goods will not benefit (with certain exceptions)

The EU-Japan EPA has not been amended however. Most importantly this means that a car produced in the UK with a significant proportion of Japanese components may cease to benefit from preferential tariff treatment pursuant to the TCA upon importation into the EU.  The problem was known to the negotiators.  The UK-Japan CEPA provides that Japan will endeavour to negotiate parallel provisions in the EU-Japan EPA. Also, the UK attempted to include in the TCA provisions for diagonal cumulation with common free trade partners.  The EU has refused to allow this however.

Exception for electric cars

A few adaptations to the origin rules have been achieved but are often temporary.  One such is that the maximum value of non-originating materials for electric vehicles has been increased to 60% until 31 December 2023 and 55% until 31 December 2026 so as to allow imported batteries to be used in their construction (see Annex ORIG-2B of the UK-Japan CEPA) .

Prospects for improvements – what can be done

It is to be expected that a number of the EU’s free trade partners will increasingly object to the change in the treatment of certain supply chains.  An argument could be made the EU is no longer granting the market access that it had promised and that the free trade agreements need to be adjusted. There are also protests from some traders within the EU at the change of treatment and the EU could possibly respond to these with unilateral changes to EU customs regulations.  Finally, some special origin rules could also be argued to be contrary to the non-discrimination clauses of the WTO Agreement.

If you would like to discuss the problems caused by the origin rules an possible solutions, please contact the authors listed below.