One of the potential consequences of the U.S.-China trade dispute is that more companies may consider supply chain sourcing from third countries such as Mexico. This may include direct sourcing in the third country or the processing of Chinese components into finished products in third countries prior to entry into the United States. There are a number of issues to consider where the processing of Chinese products subject to section 301 duties occurs in third countries prior to importation in the United States.
For example, the imported Chinese components processed in a third country may nonetheless be subject to section 301 duties when imported into the United States unless they are “substantially transformed” into a new and different article of commerce in the third country. This is a product-specific analysis and involves a review of components and production steps. Recently, the Court of International Trade ruled that mere assembly of foreign component parts does not constitute substantial transformation. (Energizer Battery Inc. v. United States, 190 F. Supp. 3d 1308 (Ct. Intl. Trade 2016). The decision noted that, “whether there has been a substantial transformation depends on whether there has been a change in the name or use of the components.” The court focused not on whether “the components as imported have the form and function of the final product” but rather “whether the components have a pre-determined end-use at the time of importation.” The court suggested that the imported parts would need to undergo “further work” beyond mere assembly to be considered substantially transformed.
It is worth noting that Customs cited the Energizer action in its recently released ruling, HQ H300226, in which the importer argued that electric motors should be considered country of origin Mexico where the Chinese components are imported to Mexico and assembled into the electric motors. Customs ruled that based on the NAFTA tariff shift rules, the product qualified as a product of Mexico only for marking purposes; however, in accordance with Energizer, the production process performed in Mexico is “mere simple assembly and the foreign subassemblies are not substantially transformed.” Accordingly, for origin purposes, the country of origin of the motor remained the country of origin of the parts — China.
HQ H300226 is significant as it is the first ruling issued post enactment of the Section 301 duties which makes the distinction between country of origin for marking vs. origin purposes. Customs makes it clear that when “considering a product that may be subject to antidumping, countervailing, or other safeguard measures, the substantial transformation analysis is applied to determine the country of origin.” The same would be true of section 301 duties. Once the product is determined to be country of origin China, the importer will be assessed the additional Section 301 duties of 10-25%.