October 8, 2008

PROPOSED RULE CALLS FOR SUBSTANTIAL CHANGE TO SUBSTANTIAL TRANSFORMATION

BUT NET RESULT FOR GOVERNMENT CONTRACTORS IS UNCLEAR

A rule proposed by the Bureau of Customs and Border Control (Customs) would create a need for federal government contractors to revisit their Trade Agreements Act (TAA) certifications to ensure they are selling compliant supplies.

The rule would amend Customs’ regulations to establish a uniform method – commonly called the “tariff shift” test – for determining the country of origin of imported merchandise. Under this method, Customs essentially asks whether a sufficient change in tariff classification for an imported good has been effected by processing within a given country. If the answer is yes, that good is deemed “substantially transformed” and a product of that country.

Customs determines origin for many purposes, including admissibility into the US, eligibility for preferential trade programs and marking requirements. Depending upon the type of determination, Customs typically applies either the tariff shift or a case-by-case, fact-sensitive “substantial transformation” test, which often involves inherently subjective judgments. Under the proposed regulation, the tariff shift and related rules, which are widely viewed as the more objective approach, will apply across the board to all country-of-origin determinations by Customs.

Why does this matter for government contractors? Because Customs has regulatory authority to issue binding country-of-origin determinations and advisory opinions relating to federal procurements. When doing so, Customs currently applies the more subjective substantial transformation test. However, under the new rule, the tariff shift will govern. And, while the result often will be more predictable, it might not always be the same. Further, when tariff-shifting cannot squarely be applied to a good, the related rules also involve subjective determinations.

Through TAA certifications, government contractors represent that all end products offered are end products of the US or certain designated countries. To represent this for end products containing materials from non-designated countries (such as the People’s Republic of China), contractors must determine under the more subjective analysis whether, due to manufacturing processes within the US or a designated country, the supply is substantially transformed.

Because the proposed rule explicitly adopts the tariff shift for procurement determinations by Customs, it is clear that a challenge brought at Customs (or a request for a Customs opinion as to one’s own supplies) would be analyzed under that test. However, it is not clear, at least at this juncture, that other tribunals would necessarily follow the new rule.

For instance, the Government Accountability Office and the Court of Federal Claims have addressed TAA compliance in bid protests. The court has also addressed TAA compliance in claims litigation, where the government sought a refund for non-compliant supplies. TAA compliance can also arise in federal district courts in False Claims Act cases or if the Department of Justice initiates action on an inaccurate certification.

While government contracts tribunals can – and often do – look to Customs for guidance, it is unclear whether they must – or will – adopt the tariff shift as the governing test when determining origin or assessing the reasonableness of a contracting agency’s determination. Following precedent from various courts, government contract tribunals historically have applied the more subjective test.

In summary, the proposed rule is intended to create greater predictability in resolving country-of-origin issues, which should strengthen contractors’ confidence in their certifications and reduce the guesswork enshrouding this complicated area of law. While this might hold true in the Customs context, it is unclear – without further regulatory guidance – that the same result will be achieved for procurement purposes.

Due to the significant civil, criminal and administrative penalties that can result from non-compliance with the TAA, should the rule become effective, best practices dictate that contractors analyze their supplies under both tests until the issue is resolved.

An earlier version of this article was published in Washington Technology in September 2008.