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NAFTA and Canadian business: Time for a ‘Plan B’

Russ Crawford is a Tax Partner and NAFTA leader with KPMG in Canada. Angelos Xilinas is a partner, trade and customs with KPMG in Canada.

The fourth round of NAFTA negotiations opened this week with more questions than answers. While the teams announced a new North American free-trade agreement competition chapter, the U.S. President again used a number of events and vehicles to talk about the need to terminate the deal. The Prime Minister, for his part, acknowledged that the outcome was unpredictable. That said, other signals from the Trump administration and Congress would point to support for a modernized NAFTA.

With so many conflicting messages about the state of the negotiations, Canadian business leaders are getting increasingly nervous about the outcome. Despite announcements in recent weeks on new chapters around competition, supporting trade opportunities for small and medium-sized businesses (SME), and developments regarding core procedural issues such as automatic declarations of origin, the absence of any formal proposals to amend the deal's most contentious issues is raising growing concerns.

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Of particular concern is the emergence of new proposals from the United States that Canada and Mexico are unlikely to accept, and that could cause significant issues for businesses on all sides of the borders. The United States has taken a harsher tone on rules of origin; proposed a sunset clause that would terminate the agreement after five years, unless all countries agreed to extend; and suggested new seasonal restrictions on imports of agricultural goods.

As well, some in the trade community believe that the Trump administration has not submitted text on key contentious areas because it plans to submit a letter withdrawing the United States from NAFTA. While difficult to believe that a deal won't be struck that works for all three countries, it is incumbent on Canadian business leaders to start considering their options and plan for various contingencies.

One of the biggest risks to business in these negotiations is not a renewed NAFTA with less favourable terms but a dissolution of the agreement without a replacement – or a new agreement that expires every five years. Business needs to know the rules of the game are going to remain consistent and predictable. The lack of a trade agreement or one that can be rewritten every five years could make it impossible to secure needed financing to make the investments necessary to keep their companies sustainable and competitive.

Uncertainty regarding the application of NAFTA provisions will affect smaller enterprises the most. SMEs likely won't have the resources or infrastructure necessary to adapt to a world of unpredictable rule changes.

On the positive side, the trade representatives from all three countries know that continuing predictability and clarity in the agreement is of utmost importance. What is not clear is whether they will be able to be in a position to finalize a deal.

Given this environment, Canadian business leaders need a "Plan B" to be ready for a wide range of outcomes to the current trade and customs rules.

  • A U.S. withdrawal from NAFTA: As there is a six-month phase-out period from the time written notice is provided, the impact of a withdrawal will not be immediate. After the six-month period, businesses may be able to apply the provisions of the Canada-U.S. free-trade agreement, which was superseded when NAFTA came into force. Further, if the United States were to withdraw from NAFTA, the agreement would still apply between Mexico and Canada. In all cases, business needs to examine their supply chains and what new duties could be imposed, understand the flow-through impact on prices and their competitive position in the marketplace. They also need to understand if there will be impacts on their ability to send people to the United States to work with suppliers and provide after-sales service to American customers.
  • Changes to the NAFTA rules of origin: If changes to the rules of origin make them too onerous and costly to administer, or if preferential rates between the United States and Canada are no longer available, businesses should assess the costs associated with paying duty at the higher most-favoured nation (MFN) rate. If these costs are prohibitive, businesses need to assess supply-chain changes to take advantage of other preferential tariff regimes, assess whether changing the structure of their import transactions can lower the customs value and examine their customs transactions to identify any other potential duty-savings opportunities.
  • Other preferential tariff regimes: Canada currently has access to preferential tariffs for certain goods under the General Preferential Tariff, the Least Developed Country Tariff, the Commonwealth Caribbean Country Tariff, the Australia Tariff and the New Zealand Tariff. There are also 11 free-trade agreements currently in force (not including NAFTA), as well as other agreements either concluded, in negotiations or in exploratory discussions. These agreements could provide comparable or better trade options.

For example, Canadian companies can look to trade more with the European Community and benefit from preferential rates under CETA, which came into force provisionally on Sept. 21, 2017. Most goods moving between Canada and the 28 European Union countries are now eligible for duty-free treatment. Upon coming into force, CETA eliminated approximately 98 per cent of all tariffs between Canada and the EU, with another 1 per cent to be phased out over a period of up to seven years.

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Uncertainty about NAFTA may be the trigger to get Canadian businesses to seriously think about leveraging the country's ties to international markets to build new supply-chain opportunities and diversify trade.

Andrew Scheer says Trudeau playing catch-up on NAFTA (The Canadian Press)
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