The Ins and Outs of Canada’s New Trade Agreement and NAFTA Replacement, the USMCA
October 3, 2018
On September 30, 2018, Canada and the United States resolved outstanding trade issues and announced that they, together with Mexico, agreed to a trilateral United States-Mexico-Canada Agreement (USMCA). Once ratified, the USMCA will replace the existing trilateral North American Free Trade Agreement (NAFTA), which has been in place between the three countries since 1994.
The USMCA represents an agreement in principle and concludes the renegotiation of the NAFTA, which commenced in August 2017. While the USMCA has been described as a new trade agreement that replaces NAFTA, many of its chapters cover the same or similar issues and many of the provisions are unchanged. That said, the USMCA does make some significant changes to the rules governing trade between the three parties. Changes will affect many industries including oil and gas, automotive, agriculture, textiles and apparel, alcoholic beverages, and many others.
The USMCA is a complex agreement, comprising 34 chapters, numerous annexes, and a number of side letters, all of which contain details of the new rules. The USMCA will not take effect immediately. The next steps are for the leaders of the three parties to sign the agreement, and for each country to ratify and implement the USMCA. It is anticipated that the USMCA will take effect on January 1, 2020.
In the meantime, NAFTA will continue to apply to trade between the three countries. In addition, the USMCA does not affect the U.S. tariffs on steel and aluminum imposed pursuant to section 232 of the U.S. Trade Expansion Act of 1962. The U.S. will continue to impose these tariffs against Canada. However, the U.S. has indicated it will no longer look to impose a 25 per cent tariff on motor vehicles made in Canada.
The USMCA also contains key changes. In particular, the USMCA increases the required level of local content of automobiles and auto parts for auto exporters in Canada or Mexico to export automobiles tariff-free to the U.S. Canada also made concessions on supply-managed markets, including by opening up a portion of its dairy market to U.S. imports. In the oil and gas industry, Canada will no longer be subject to the proportionality provisions in NAFTA’s energy chapter, which should permit the expansion of oil and gas exports beyond the U.S., and a change to the oil and gas rules of origin will allow Canadian exporters to more easily qualify for duty-free treatment for shipments to the U.S.
Overall, the USMCA appears to satisfy certain objectives of the U.S., Canada, and Mexico, and more importantly, brings to an end the uncertainty caused by the ongoing negotiations. If ratified, the USMCA will keep the economies of Canada, the U.S. and Mexico linked for the next 16 years.
DISPUTE RESOLUTION IN TRADE REMEDY CASES REMAINS
A key negotiating objective for Canada in the USMCA was the retention of the dispute resolution mechanism under Chapter 19 of NAFTA. Under Chapter 19 of NAFTA, a Canadian exporter can initiate proceedings and seek relief from a NAFTA panel if anti-dumping or anti-subsidy tariffs are used to block or target imports on the basis that the exporter’s products are subsidized or priced below their normal value. In principle, the trade panel’s decisions could be enforced on the same terms as a domestic court and the offending country could be ordered to refund unjustified trade tariffs.
This mechanism has been retained under Chapter 10, Section D of the USMCA in substantively the same terms of Chapter 19 of NAFTA. This will continue to offer significant benefits to Canada compared with other alternatives, such as relying on World Trade Organization (WTO) dispute settlement. The USMCA trade panel has the same powers as a domestic court (which WTO trade panels do not) and cannot be appealed in domestic courts. Canada has used the Chapter 19 mechanism under NAFTA 45 times to challenge U.S. trade actions (far more than the U.S. or Mexico), most notably in relation to softwood lumber. Although implementation of NAFTA panel decisions by the United States remains poor, a series of decisions in Canada’s favour in the mid-2000s were widely thought to have strengthened Canada’s negotiating position in the softwood lumber dispute.
INVESTOR-STATE DISPUTE SETTLEMENT IS ABOLISHED
In addition to the dispute settlement mechanism in Chapter 19, NAFTA also contained an investor-state dispute settlement (ISDS) mechanism, which allowed an aggrieved investor or company whose rights had been infringed to appeal to a NAFTA arbitration tribunal, rather than sue the host state in its own courts. The USMCA will eliminate this mechanism for Canada within three years of implementation, and mostly eliminate it for Mexico (subject to key exceptions for energy and telecoms).
RULES OF ORIGIN REQUIREMENTS ARE INCREASED FOR THE AUTO INDUSTRY
For automobiles imported from outside a country, these rules of origin determine what percentage of the automobile must be made from inputs sourced from within the free trade area if it is to benefit from duty-free treatment under the USMCA. NAFTA required that 62.5 per cent of the inputs going into a car made in Canada had to be made from inputs from North America in order to benefit from the tariff exemptions afforded under the agreement. The USMCA will gradually increase that percentage to 75 per cent.
MINIMUM WAGE REQUIREMENTS
A new provision under the USMCA requires that at least 30 per cent of cars (increasing to 40 per cent by 2023) must be made by workers earning at least US$16 per hour in order to benefit from the USMCA. This threshold likely will not pose a significant barrier to Canadian automakers, but may shift some production away from Mexico and towards the U.S. and Canada.
CANADIAN DAIRY AND OTHER SUPPLY-MANAGED MARKETS
Canada has long maintained a system of supply-managed markets for certain agricultural products such as dairy, eggs and poultry. This system includes production quotas (restricting how much dairy can be produced in the country), minimum pre-determined prices, and high tariffs under “tariff-rate quotas” or TRQs (restricting how much competitive dairy can enter the country). TRQs are numerical quotas that generally apply very low or no tariffs to imports as long as they remain below a set quota, and significantly higher tariffs once the quota for that product is reached within a certain period.
Under the USMCA, Canada has increased U.S. access to its dairy market, allowing the U.S. to export the equivalent of 3.6 per cent of Canada’s dairy market. The USMCA includes new TRQs in favour of the U.S. for dairy products such as: milk, cream, skim milk powders, butter, cheeses, yogurt and buttermilk, whey powder, concentrated milk, and ice cream, among other things.
Canada will also give the U.S. deeper access to its poultry and egg markets, increasing the metric tonnage of chicken imports to up to 57,000 metric tonnes (from 27,000 metric tonnes under NAFTA) and an additional 10-million dozen eggs.
OIL AND GAS
Article 605 of NAFTA imposes certain requirements on Canada with respect to exports of energy and basic petrochemicals, requiring that any export measures be applied in such a way that the proportion of total supply that was shipped to the U.S. in a representative period remains unchanged. This requirement does not appear in the USMCA and therefore should assist in permitting Canada to expand its exports to markets beyond the U.S.
In addition, the USMCA includes a change to the rules of origin for crude oil that should make it easier for exporters to qualify for duty-free treatment on shipments to other USMCA parties. In particular, the origin of the diluent that is used to facilitate the transportation of crude petroleum oils is disregarded, provided that the diluent constitutes no more than 40 per cent by volume of the good.
NO GOVERNMENT PROCUREMENT
There are no provisions on government procurement under the USMCA between Canada and the U.S. This is a notable omission, as government procurement was a significant focus of the Canada-EU Comprehensive Economic and Trade Agreement, or CETA, and the USMCA contains procurement provisions that apply only to the U.S. and Mexico. The WTO Agreement on Government Procurement will continue to govern procurement between Canada and the U.S.
DE MINIMIS EXCEPTIONS FOR DUTY-FREE SHOPPING
Canada has agreed to increase the de minimis exception (applicable to express shipments) from duties on goods crossing the border to C$150 and from taxes to C$40 (up from C$20 under NAFTA). This de minimis exception is a threshold for duty-free shopping, which establishes the amount that Canadians can buy from the U.S. and import into Canada without paying duties.
INTELLECTUAL PROPERTY REGIMES EXTENDED
The USMCA strengthens intellectual property protections. Specifically, the USMCA extends market exclusivity rights for biologic pharmaceuticals (pharmaceuticals made from biological compounds) from eight to 10 years. This means that U.S. brand-name drug companies will be able to sell pharmaceuticals in Canada for 10 years before Canada’s generic drug makers can enter the market. In addition, it extends Canada’s copyright terms from 50 years after the death of an author to 70 years (the current length in the United States).
NAFTA contained a cultural exemption, which preserved protections for Canadian industries on cultural grounds, such as Canadian television and music. The Government of Canada had stated repeatedly that maintaining this exemption was of vital importance and the exemption remains in place under the USMCA.
While none of the U.S., Mexico or Canada actively intervene in currency markets for the purposes of trade competitiveness, the USMCA contains a new provision that parties should avoid manipulating exchange rates and engaging in tactics such as competitive devaluation. This provision may indicate a new standard for future agreements with the U.S.
The USMCA requires Canada to give the U.S. 90 days’ notice before it commences negotiations for a trade agreement with a “non-market economy”, upon which the U.S. has the right to terminate the USMCA. The provision is widely seen as a signal in the U.S.’s growing trade war with China, and a measure to prevent Canada from becoming a “back door” for Chinese imports.
The U.S. had been considering imposing a 20-25 per cent national security measures tariffs under section 232 of the (U.S.) Trade Expansion Act of 1962 on Canadian cars and auto parts imported into the U.S. Under the USMCA, the U.S. has agreed to exempt Canadian auto and auto parts imports from section 232 tariffs up to certain import thresholds, which have also now been raised. The U.S. has agreed to increase the permissible import quota to 2.6 million Canadian cars (Canada currently sells 1.8 million cars into the U.S.) and up to C$32.4-billion worth of auto parts without being subject to section 232 tariffs.
The USMCA also now provides for a 60-day notice period before any section 232 tariffs can be applied to Canadian imports, and Canada is expressly permitted under the terms of the agreement to take retaliatory action if any section 232 action is inconsistent with NAFTA, USMCA, or WTO rules.
New to the USMCA, the agreement contains a “sunset clause”, which means that the USMCA is scheduled to expire at a set date unless renewed. Although the U.S. administration had initially sought a five-year sunset clause, Canada, the U.S. and Mexico have agreed to lengthen it to a 16-year term, renewable following a six-year review.
The USMCA is being described as a new agreement and a replacement for NAFTA. While the USMCA will make some significant changes to the trade relationship between the U.S., Canada and Mexico, many of the key NAFTA provisions remain intact in the USMCA. An advantage of the USMCA is that it brings a level of certainty to businesses in North America that has been absent since the start of the NAFTA renegotiations in August 2017. The USMCA is a technically complex agreement and contains many details that should be reviewed by those companies doing business in the USMCA markets.
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