This article will discuss a type  of international audit intended on verifying  compliance with  international trade rules that indicate when a good is made in a specific country or region. These  rules are called  “Rules of Origin” and  the type of audit is generally called  “Origin Verification”.

Rules  of  origin  are  in  essence technical rules  with  economic principles that oblige  the  producer to  maintain a minimum percentage of domestic content in the  finished good  by sourcing raw materials and/or manufacturing the good  domestically (i.e. sufficient American parts, inputs and  value  added to consider the  good  is made in the  U.S.). Each product has its own rule of origin  and  may be different in each trade agreement.

Once  a producer is sure  it has  complied with  the  domestic content requirement, it may  issue  a document attesting such compliance (this document is generally called certificate of origin). The certificate of origin (CO) can be issued by the producer, exporter, or by an administrative authority from the country where the goods were produced, depending on  the  treaty. This  certificate of origin  is then generally filed  together with  the  import documents at  the  time  of importation to obtain a preferential duty.

Background

The  Mexican consumer market has  grown steadily in  the  last  20 years  by  a rising  middle class  and  population.2
Statistics show  that the  Mexican economy imported over  $221 billion USD in 2005, $256 billion USD in 2006, $281 billion USD in 2007, and $308 billion USD in 2008. The worldwide economic crisis led to a drop in imports during 2009 ($234 billion USD), but quickly recovered with $301 billion USD in 2010.

By and  large  most of these imports were  made from  countries with  which Mexico  has  a free trade agreement. Until now,  Mexico  has signed 12 trade treaties, encompassing the  majority of the  Americas and  most major markets (U.S., Europe, and  Japan). 3

International audits are  fundamental to  prevent illegal  trade practices, hence avoiding market distortions and protecting the  country’s tax revenue. From  2007 to 2009, Mexican authorities initiated 4,500 cases  against technical contraband, and  assessed unpaid tax liabilities for over  $8.6 billion USD.4  Technical contraband occurs when the documents filed  at the  time  of importation appear to be  correct and  legal,  however they  are  false  or purposefully contain incorrect information. In recent years  it has  replaced traditional contraband. To counter this  new  practice, authorities rely on  many resources, including international audits or origin  verifications. Many  honest companies have  been and  will be affected by a recent surge  of origin  verifications and  it is important for company officials  to respond to any communications sent  by the Mexican government and  prove  compliance with trade rules.

Because of the size of the North American market and  due  to the significant amount of trade among the Parties of the North American Free  Trade Agreement (NAFTA), we will focus  in  this  article on  the  origin  verification procedure stipulated in the NAFTA.

NAFTA Origin  Verifications

Compliance with NAFTA rules  of origin  (mostly contained in Chapter Four)  is assumed when a certificate of origin  is issued. NAFTA certificates of origin  can be issued by either the producer or exporter of the good  (in this last case with a written representation from the producer).

A downside to NAFTA certificates of origin  is that they  can  easily be drafted with  false or inaccurate information, or signed by  someone other than the  producer or  exporter.  This  has  opened the  door  to  abuses by  unscrupulous merchants resulting in losses  to the  domestic industry and  in government revenue.   NAFTA origin  verifications are provided in Article 506 and  may  be conducted through written questionnaires to producers and  exporters, or direct visits to their premises.

The Mexican Federal Tax Court has established precedents that distinguish questionnaires from visits to premises as two different types  of proceedings, each with  its own  set of rules.5 It also has  ruled that notifications in a different country must be made using certified mail and delivered to the legal representative of the company with proof of receipt.6

Written questionnaires primarily ask the recipient if it issued the certificates of origin. Afterwards the government may request evidence to show  the  company complied with  the  rules  of origin.  Producers may  additionally be  asked to describe the productive process, including the location where each step  of the process took place, and  to provide bills of materials, invoices, with  details on  the  origin,  tariff classification, and  supplier’s name. A surge  of these types  of audits is explained by the fact that authorities have detected cases  where CO were signed by phantom companies.7

With regards to visits to the  premises, these have  the  purpose of reviewing a foreign company’s records and  observe the facilities used in the production of the good. Prior to conducting a visit, the inspecting customs administration (i.e. Mexican Customs) must deliver a written notice of its intention to conduct the visit to the exporter or producer whose premises are to be inspected, and  to the customs administration of the country in whose territory the visit is to occur (i.e. U.S. Customs). Visiting authorities must obtain prior written consent of the  exporter or producer. Furthermore, authorities shall allow audited companies the appointment of two witnesses during the visit.

Importance of Origin  Verifications

The  trend of  increasing international audits will  probably continue, in  an  effort  to  deter foreign and  domestic companies from engaging in technical contraband. Legitimate and honest companies will likely be affected and hence it is important that they  take  precautions. This means that companies must respond to any official communications served by  the  Mexican government, complete CO accurately and  keep  accounting and  production records long enough to back  the  CO.  Under Mexican law, imports are generally auditable 5 years  after  importation, but  since  an origin  verification may last up to 2 years,8 it is recommendable that importers, exporters and  producers keep  records for longer periods of time  (how much time  depends on the type of goods imported and  the type of importation).

The  competent authority in Mexico  to perform origin  verifications is the  Central Administration for Foreign Trade Taxation. It has the legal authority to verify compliance with international treaties that Mexico is a part of and  can audit any individual or legal entity including importers, exporters, producers, and  liable third-parties. 9

As mentioned above, the Mexican government notifies foreign companies that produce and/or export to Mexico using CO. These  notifications are  done using an  international carrier. Many  times these notifications (questionnaires or request for visits) are not  attended by U.S. or Canadian companies and  forgotten. The fact that a specific company did not  respond to an  official  communication will not  prevent the  Mexican government from  making a determination. Officials can  only make decisions based on information they  have,  and  if the  foreign company did not  respond, most likely the decision of the Mexican authority will negatively affect them. The decision by the Mexican government can be to  (i) invalidate NAFTA certificates of origin  issued by the  producer or  exporter, (ii) deny  NAFTA preferential duty treatment for the products exported under those certificates of origin, (iii) initiate legal procedures against the importers who  used those NAFTA certificates of origin  [government tries  to  collect the  normal import duty  rate,  plus  VAT, applicable antidumping duties, fines, penalties and  surcharges], (iv) begin new NAFTA origin  verifications to the same producer and exporter for other fiscal years, and (v) deny future NAFTA preferential duty treatment for identical goods.

An important thing to consider is that even  though it is the importer of record into  Mexico the entity against which a legal procedure is initiated by the government to collect unpaid duties because of the mistakes made by the producer or exporter who issued the NAFTA certificate of origin,  this Mexican importer may then initiate a civil or commercial claim  against the  producer or exporter in the  United States or Canada (in addition to any contractual obligation that may exist).

Aside from  the  damage that may  be caused to producers and  exporters that do not  pay sufficient attention to origin verifications, importers often become innocent bystanders, and  most of the  time  they  never find  out  about the investigation in  the  first  place. This  is  supported by  Mexican judges, who  have  ruled that these international proceedings have the sole purpose of verifying certificates of origin, which can only be issued by a producer or exporter abroad.10 Since information is not  shared by the Mexican government with importers up until  they are sanctioned, it is recommended that producers and  exporters inform their Mexican clients of origin  verifications, so that importers may assist  in any way possible, including access to documents and  contact with Mexican officials.

Special   attention is  given   by  authorities to  merchandise  considered  “sensitive” by  the   Mexican government. Companies in the textiles, toys, and  steel industries are most likely to become subject to investigation, and  should pay closer  attention to all mail deliveries.