Brexit Poses Issues For Airports, Airlines

The United Kingdom’s split from the European Union could leave the nation and United States without a trade agreement to manage the aviation industry. The aviation industry currently operates between the two nations under the Open Skies agreement signed by the U.S. and the EU in 2007. However, the U.K. will no longer be covered under the agreement once it leaves the bloc and, while it is still an EU member, cannot negotiate a new agreement either.

Open Skies agreements are bilateral air service agreements (ASAs) the U.S. government negotiates with other countries to provide rights for airlines to offer international passenger and cargo services. Agreements cover a number of significant matters including rights to fly over and land in territories, regulatory requirements, competition, commercial opportunities, customs and duties, and landing charges.

The situation is creating uncertainty and legal challenges in one of the most important components of international trade. Forty percent of the EU’s air traffic to the U.S. departs from U.K. airports and nearly 48,000 flights left the U.S. bound for the U.K. in 2016 alone. Commercial arrangements in the aviation industry including for airlines, air freight companies, airports and all related businesses depend on the Open Skies agreements as a basis for their contractual arrangements. Some U.S. airlines are already seeking to renegotiate deals with U.K. airports to ensure that break clauses and other mechanisms are inserted to deal with any uncertainty following Brexit, which under Article 50 has a deadline of March 30, 2019. Post-Brexit flight bookings may also need some form of provision to deal with contractual rights to hedge against major changes in the event that the Open Skies agreement is terminated for the U.K.

Michael O’Leary, CEO of Ryanair, Europe’s largest airline, told reporters on Aug. 2 that without some understanding of what a future agreement will look like airlines won’t be able to plan their 2019 flight schedules.

“There is going to be a serious disruption unless the British government can negotiate an agreement by around this time next year,” Ryanair said.

In late July, Airlines for America, the nation’s largest aviation trade group, issued a formal statement calling for the airline industry to be dealt with immediately and separately from Brexit negotiations. On Aug. 1, Reuters reported that British Transport Secretary Chris Grayling met with White House and airline officials to assure them that an agreement would be in place when the U.K. exits the EU. The Federal Aviation Administration’s chief Michael Huerta has also recently explained the seriousness of the U.K.’s situation with regards to aviation safety. Along with the other EU member states, the U.K. is currently part of the European Aviation Safety Agency (EASA), which is responsible for all aspects of civil aviation safety in the EU. Speaking at the UK’s Aviation Club, Huerta pointed out that the U.K. currently benefits from the being part of EASA and that when it leaves the EU it will need to be replaced or there would be the very real possibility of an “interruption of service.”

Faced with uncertainty of legal rights and concerns about ongoing aviation safety regulation, it is important that U.S. airlines as well as U.S. logistics and freight companies monitor the situation and plan for potential disruption. Some comfort can be taken from British Government assurances that open skies agreements and regulations will be in place when the U.K. exits the EU, however, individual commercial agreements should be reviewed to minimize risk of disruption. For instance, U.S. airlines have agreements with U.K. airports for a range of services including landing rights and leases for office outlets. All these agreements may need to be reviewed sooner rather than later so that both parties have contingencies in place to avoid any disruption as much as possible.

This post was written by G. Thomas Lee and David B. Hamilton of Womble Carlyle Sandridge & Rice, PLLC.
Get more Brexit Analysis at the National Law Review.

President Trump Shifts the U.S. Policy Towards Cuba

As we have previously reported on the growing fear that the Trump Administration would roll back President Barack Obama’s plan to normalize relations with Cuba. Then-candidate Donald Trump was calling President Obama’s deals with Cuba “one-sided” and beneficial “only [to] the Castro regime.” Last week Friday, at an event at the Manuel Artime Theater in Miami, President Trump officially announced his Administration’s new public policy towards Cuba and fulfilled a campaign promise.

Cuban FlagPresident Trump’s speech culminated in the issuance of a National Security Presidential Memorandum and an accompanying White House Fact Sheet on the U.S. Policy toward Cuba.  In sum, President Trump’s directive:

(a)  Ends economic practices that “benefit the Cuban government” by prohibiting most economic activities with the Cuban military conglomerate, Grupo de Administración Empresarial (“GAESA”). This change is most likely to affect the hotel and tourism industry sectors, since these are the industries said to be largely controlled by GAESA. A list of companies that will be on the “blacklist” will be issued by the State Department at a later date.

(b)   Adheres “to the statutory ban on tourism to Cuba,” by amending regulations related to educational travel (i.e., by ending individual people-to-people travel) and enforcing the strict record keeping requirements related to travel to Cuba.

(c)   Opposes any efforts in the United Nations or other international forums to lift the embargo on Cuba.

(d)   Supports the expansion of internet services and free press in Cuba by convening a task force that will work with non-governmental organizations and private sector entities to examine the challenges and opportunities in those areas.

(e)  Keeps in place the Obama Administration’s elimination of the “Wet Foot, Dry Foot” policy.

(f)  Ensures that engagement with Cuba in general is advancing the interests of the United States.

As explained in the new FAQs issued by the U.S. Department of the Treasury, the policy changes will not go into effect until the Treasury Department and the U.S. Department of Commerce have finalized their new regulations. Importantly, the new Cuba policy changes will not have retro-active effect. Those travel arrangements and commercial engagements that were in place prior to the issuance of the upcoming regulations will not be affected.

Al Cardenas, who heads the Latin America practice group at Squire Patton Boggs and previously served as the former Chairman of American Conservative Union and former Chairman of the Florida GOP, explains:  “Despite the emotional setting and rightful remembrance of the struggles of the Cuban people found in President Trump’s speech, which was focused on a Cuban exile audience, President Trump’s executive action preserves many of the changes made during President Obama’s Administration (some of which were outlined in President Obama’s 2014 Speech). For example, the respective embassies in Washington and Havana will remain open, the U.S. licenses issued to airlines and cruise line companies have been kept, efforts to expand direct telecommunications and internet access will continue, and the additional categories for travel to Cuba for the most part remain in place. While one-step back is the prohibition on U.S. travelers from staying at government-owed facilities, this should be a boon to the family-owned B&B’s and other rentals on the island. It remains to be seen whether there will be a significant drop off in tourist travel to the island.”

Viewed as a whole, President Trump is tightening some areas where improved economic relations with the United States could have benefitted some auspices of the Cuban Government.

This post was written by Beatriz E. Jaramillo and  Stacy A. Swanson of Squire Patton Boggs (US) LLP.

NAFTA Renegotiation Would Intend to Benefit Farmers, Ranchers

In recent weeks, the Trump administration took the first step toward renegotiating the North American Free Trade Agreement (NAFTA). Robert Lighthizer, United States Trade Representative (USTR), sent a letter to Congress placing Congress on official notice of the Administration’s intention to renegotiate the Agreement with an eye toward advancing the interests of U.S. farmers, ranchers, workers, and businesses. The USTR’s notice to Congress created a ninety-day window before formal negotiations could begin. According to Michigan Farm Bureau (MFB) Associate National Legislative Counsel, John Kran, “This is the opportunity for the country to react to the President’s notice, and for feedback from voters and members of Congress to get surfaced and shared with the Administration before the formal negotiation process can begin.” The Administration hopes to renegotiate a new NAFTA within the next six months.

In a formal statement, Zippy Duvall, American Farm Bureau Federation (AFBF) President, said the American Farm Bureau will work with the Administration, Congress, other agricultural groups as well as with officials in Canada and Mexico to rectify issues with NAFTA which have limited the trade potential of U.S. farmers, ranchers, workers and businesses. Sonny Perdue, U.S. Secretary of Agriculture, issued the following statement: “While NAFTA has been an overall positive for American agriculture, any trade deal can always be improved. As President Trump moves forward with renegotiating with Canada and Mexico, I am confident this will result in a better deal for our farmers, ranchers, foresters, and producers.” Sonny Perdue acknowledged that while NAFTA has been good for farmers, the same cannot be said for other U.S. industries, such as manufacturing.

To stay informed on the progress of NAFTA modernization, visit the Michigan Farm Bureau’s new Trade page.

Thist post was written by Aaron M. Phelps of Varnum LLP.

President Trump Closes 100 Days in Office with Trade EOs, Debate of NAFTA Withdrawal

Trade NaFTAUnder pressure to make good on campaign promises as his first 100 days in office drew to a close, President Donald Trump considered a number of new trade-related actions last week, highlighting the importance of stakeholder engagement with his Administration on trade matters.

On Wednesday, April 26, reports emerged that President Trump was seriously considering withdrawing the US from NAFTA. The action reportedly came as a surprise to many stakeholders, who were expecting trade developments ahead of President Trump 100th day in office but not NAFTA withdrawal.  President Trump ultimately decided to shelve the draft executive action following conversations with the leaders of Mexico and Canada, calls from Members of Congress, and outreach by private stakeholders, as well as meetings with his most senior advisors.

In remarks the following day, President Trump confirmed that he had been seriously considering withdrawing the US from NAFTA, reiterating his promise to pursue the strongest deal possible and pledging to terminate the agreement “if we do not reach a fair deal for all.”

On Saturday, April 29, President Trump went on to sign two trade-related Executive Orders (EO).

The first EO states that the policy of the United States will be to negotiate agreements that benefit American workers, manufacturers, farmers and ranchers; protect intellectual property (IP) rights; and encourage domestic research & development.  It is also states that the policy of the United States will be to renegotiate any existing trade agreement, investment agreement, or trade relation that, on net, harms the U.S. economic, businesses, IP rights, and “innovation rate,” or the American people.

The EO directs the Secretary of Commerce and the U.S. Trade Representative – working with the Secretary of State, the Secretary of the Treasury, the Attorney General, and the newly-established Office of Trade and Manufacturing Policy Director – to conduct comprehensive performance reviews of:

  • All bilateral, plurilateral, and multilateral trade agreements and investment agreements to which the United States is a party; and

  • All trade relations with countries governed by the rules of the World Trade Organization (WTO) with which the United States does not have free trade agreements, but with which the United States runs significant trade deficits in goods.

The second EO establishes the Office of Trade and Manufacturing Policy (OTMP) within the White House.  The OTMP’s stated mission is “to defend and serve American workers and domestic manufacturers while advising the President on policies to increase economic growth, decrease the trade deficit, and strengthen the United States manufacturing and defense industrial bases.”  Peter Navarro, previously Director of the White House National Trade Council, will serve as OTMP Director.

Last week’s developments provided the strongest indications yet that President Trump is ready to put his trade promises into action.  International stakeholders must be prepared to engage with the Administration, to emphasize the importance of trade in the Western Hemisphere for the US economy and American jobs and businesses.  The performance reviews mandated by the President’s April 29 EO – which are expected to help direct further policy-making efforts – will also provide Latin American stakeholders a chance to formally comment on the importance of existing trade relations and help to influence new policies going forward.

© Copyright 2017 Squire Patton Boggs (US) LLP

Prepared for the Border Adjustment Tax? A U.S. and Global Perspective

border adjustment taxWe have been monitoring the potential impact of the Border Adjustment Tax (BAT) across a number of jurisdictions.

In our 14 February 2017 update, we commented that issues regarding the legality of BAT and the serious and significant international implications of its application meant that the introduction of BAT was uncertain.

In this further update we consider further the issues being raised in the United States about the BAT, look at potential challenges to the BAT by the World Trade Organization (WTO) and consider what the BAT may mean for jurisdictions outside the U.S. trading with U.S. business.

U.S. concerns

The BAT is part of a comprehensive tax reform plan that would shift the U.S. system from an income tax to a cash-flow destination based consumption tax. It would operate by exempting gross receipts from exports from U.S. federal income tax, and denying any deductions for the cost of imports. The BAT would apply to sales and imports of products, services and intangibles, and affect all forms of businesses, including corporations, “pass-throughs” and sole proprietorships.

The blueprint is vague as to whether the BAT applies to financial transactions and advice. The expectation is that financial transactions will be exempted from the BAT base in some form, but that investment management services would be included in the base.

The policy of the BAT is to incentivize business activity in the U.S. by effectively penalizing imports and subsidizing exports. It is intended to discourage corporate inversions and erosion of the U.S. tax base by making transfer pricing issues moot. It also is estimated to pay for one-third of the cost of the overall tax reform bill.

The U.S. business community is pushing for tax reform in order to make U.S. companies more competitive in a global marketplace. However, because the BAT rewards exporters and punishes importers, the proposal has ironically divided the very business community that is driving reform. While importers could potentially have a larger tax liability than book income, exporters could potentially experience a negative tax situation, since their costs would remain fully deductible (assuming they were not imported). The controversy extends beyond the business community. Consumer groups fear the BAT will result in higher prices. Importers fear U.S. consumers would work around the tax by buying directly from offshore vendors. The BAT could spur increased mergers and acquisitions, as net exporters seek companies with income sufficient to offset negative taxable incomes.

House Republicans, who proposed the BAT, say the value of the U.S. dollar will increase concomitantly with the tax increase, effectively increasing the buying power of importers and thus mitigating the impact of the BAT. Economists and other analysts are mixed in their reaction as to how the dollar will react. Since many international contracts are denominated in the U.S. dollar and because many currencies are not free floating, it is unclear to what extent any fluctuation in the dollar will offset the impact of the BAT.

Further, it is unclear whether the Trump Administration will endorse the BAT. There have been mixed messages from the White House, but President Trump has made it clear he would like to impose some sort of levy on imports to level the playing field for U.S. businesses and to bring jobs back to the U.S.

WTO Implications

While the focus has been on the impact on U.S. businesses and consumers, there are significant and serious international implications of the BAT. It is unclear whether the BAT would violate WTO protocols and a challenge from the WTO seems almost certain.

The WTO’s Agreement on Subsidies and Countervailing Measures (SCM Agreement) only allows border adjustability for taxes imposed on products, the most common of these being value added taxes, sales tax and stamp duties. Whilst there seems to be some argument that a BAT is similar to a value added tax as it is focused on destination based consumption, the majority of commentators disagree with this analysis saying that the proposed BAT is a true corporate tax which in effect imposes a discriminatory subsidy in favour of net exporters. Further, the SCM Agreement prohibits the subsidizing of exports and of the use of domestic over imported goods.

Article II of the General Agreement on Tariffs and Trade (GATT) prohibits charging tariffs in excess of those in each country’s tariff schedule. The denial of deductions for the cost of imports could be considered equivalent to a tax on the imports themselves. In WTO terms, this could be viewed as the imposition of tariffs in excess of those provided for in the U.S. schedule or might violate the Article II requirement not to impose “other” duties or charges on imports. Article III of the GATT, which sets forth what are known as “national treatment” principles, generally requires that imports be treated no less favorably than domestically-produced goods. To the extent the BAT permits certain deductions (such as the cost of domestic wages), and thus generates lower tax rates for domestically-produced goods, while denying the same deductions for the same imported products, it would seem to violate the basic national treatment rules of the WTO.

The Effects of the BAT will extend far beyond the U.S. border

The European Union (EU) has already clarified it will not stand by without taking responsive action. Officials from jurisdictions like Canada, Mexico and Germany, have indicated their disapproval and concerns about the BAT. The impact on tax treaties, intended to prevent double taxation, is unclear. Many think a U.S. exemption from taxation of exports will result in a shift of the location of taxation, with non-U.S. jurisdictions taking custody of the income and taxing it. Countries around the world are concerned about how the denial of a deduction for the cost of imports and the strengthening of the U.S. dollar will affect the demand for their products, and their ability to afford products from the U.S.

Being a destination based cash flow tax, the BAT is not consistent with a corporate tax system, it goes against current principles of international taxation underlying the double tax treaties, and is not in alignment with the more recent global Base Erosion and Profit Shifting Rules (BEPS) initiatives launched by the Organisation for Economic
Co-operation and Development (OECD), Australia and the European Union.

Initial observations as to the BAT:

  • Granting a corporate income tax exemption on income derived from exports leads to a reduction of the income tax base and qualifies economically as a subsidy.

  • Disallowing a deduction for expenses relating to imports from the U.S. corporate tax base is effectively an increase of the tax base.

  • Due to its nature as a destination-based (cash-flow) tax, it is often compared to the European style value added tax (VAT) or the Australian goods and services tax (GST). However, the proposed BAT substantially differs from VAT and GST, e.g., in that:

    • VAT and GST is typically economically neutral for most businesses; and

    • end-consumers bear the same VAT burden irrespective of whether the services and supplies originate from the domestic market or from abroad.

  • Materially, the BAT appears to be a customs duty collection tool dressed in an income tax garment.

Economically, it has been said that BAT will eventually be trade neutral, due to the expected increase of the value of the U.S. dollar, however the value of a currency is also influenced by many other factors. In addition, it may be questioned whether (potential) effects on the exchange rate can be taken into consideration when analyzing and discussing the application of existing domestic and international tax law.

It is too early to finally assess the potential reaction of other countries on a potential enactment of the BAT by the U.S. In case of an enactment, many details will have to be better understood such as whether and how cross-border income payments from outside the U.S. (e.g., interest, royalties, dividends) will be subject to tax but exempted or rather be excluded from tax. In case of substantial frictions with the current tax systems, the reaction in Europe for example, may be a combination of both, a reaction at EU level as well as consequences drawn by individual member states.

Some states may question the income tax nature of the BAT or deny certain benefits such as treaty benefits based on applicable “subject-to-tax” clauses or alike. Whether or not certain states will go beyond that by requesting changes to the existing Double Taxation Treaties or their interpretation remains to be seen. Why for example should a country apply reduced withholding tax rates on royalties or alike if the respective income is not taxed in the U.S. for reasons of impeding the free trade between the U.S. and that particular country?

BAT may well also impact the current approach to globally harmonize the common understanding of fair international taxation, including the battle against the so-called BEPS which was triggered by biased rules governing international taxation.

Australia

Australia has been an early adopter for many of the OECD BEPS measures. It has recently passed legislation to implement a diverted profits tax, similar to that in the United Kingdom, a “Netflix” tax being a GST on intangible supplies via a digital platform operator by non-resident suppliers to Australian consumers. It has also introduced the Multinational Anti Avoidance Law to combat tax avoidance by multinational companies operating in Australia.

These measures show an increasing focus on cross border flows of business, and a move toward a destination model of taxing rather than an origination model. That is consistent with the BAT principles. However, given that the U.S. is Australia’s biggest trading partner and a destination of choice for many Australian companies seeking to expand globally, the impact of the BAT for Australian business cannot be underestimated.

While much of the focus in the U.S. has been on the impact of BAT on the import and expect of manufactured goods and products, cross border utilisation of intellectual property, intangibles, and management and head office charges are likely to be an area of ongoing focus as the BAT works its way through the legislative agenda.

France

The BAT could jeopardise the application of the tax treaty entered into by the U.S. and France. According to the most recent case law of the French high administrative court (Conseil d’Etat), treaty benefits must only be granted where there is an effective double taxation. If a French company pays a royalty to a U.S. company, such royalty will be exempt in the U.S. and the French revenue may take the view that the treaty does not apply. French domestic withholding tax of 30% may apply accordingly.

The BAT would clearly contradict some of the provisions of this treaty. By way of example, Article 7 provides that in determining the profits of a permanent establishment, there shall be allowed as deductions expenses which are reasonably connected with such profits, whether incurred in the State in which the permanent establishment is situated or elsewhere.

Germany

Germany has also been an early adopter of the BEPS rules – to the extent such rules were not already enacted before as German rules fighting cross-border base erosion and profit shifting were already rather sophisticated.

A mere reduction of the U.S. corporate income tax rate itself should generally not be of a concern from a German tax perspective. However, for purposes of the application of the Controlled Foreign Corporation (CFC) and Passive Foreign Investment Company (PFIC) rules pursuant to the German Foreign Tax Act, there will be an issue where the effective corporate income tax burden in the U.S. drops below 25%, measured by German tax standards.

However, Germany would certainly not welcome substantial single-sided impediments on the free trade imposed by BAT or other means.

United Kingdom

For United Kingdom businesses that export to the U.S., the introduction of a BAT could have far reaching consequences for sales, FX strategy and business organisation.

One area of particular difficulty relates to cross-border financial services (UK outbound and inbound): it is not yet clear how a BAT would deal with these (VAT systems are themselves complex in this area). Useful practical strategies may be drawn by U.S. businesses in conjunction with advisers both in the U.S. and jurisdictions with VAT systems, like the United Kingdom, as and when any BAT reform is rolled out in detail.

On a more general level, tax issues have gained a higher profile in the UK over the last few years. Like many other jurisdictions the UK is actively adopting the recommendations of the OECD’s BEPS initiative and actively encouraging EU policy to endorse the same. The UK’s implementation of these OECD recommendations has resulted in the UK seeking to tax profits created in UK, and trying to ensure that where value has been created in the UK that value is not artificially diverted for tax purposes to offshore jurisdictions.

The current UK Government’s enthusiasm for these OECD initiatives (and the automatic exchange of tax information including private tax rulings) is a continuation from the previous administration, faces little or no political opposition and is not in any way contaminated by BREXIT.

It can be noted that the OECD BEPS initiative’s overarching economic goal to ensure that value is taxed where it is created (not located) in fact, with increased attribution to human resource (rather than capital or IP), is not necessarily incompatible with the political objective of the Blueprint to increase value creation in the U.S. (and taxing it there).

Global high brand value service and product suppliers, and other businesses which are head-quartered outside of the UK, argue that the value of their sales derives from their domestic jurisdictions where their global high value brand products or IP was developed and where their technicians, designers, board etc. are based. As a result, value is not derived from a UK based sales centre, the services of which, if outsourced, would only cost a small amount in fees or commissions. It will be interesting to see how the lobby groups for U.S. based multinationals and a post-BREXIT UK each respond to the EU Commission’s state aid challenges, which were aimed at preventing low EU tax on EU sales. It may prove harder to resist greater taxation in the EU if there is no domestic tax in the U.S. in relation to the EU operations.

In addition to the policy arguments there are also technical issues with how the UK’s value based approach will sit with the proposed destination based approach in the US. For example, the U.S.-UK double tax treaty currently deals with direct taxes (such as federal profits, income and gains taxes) and is predicated on traditional tax bases such as residence and source and does not address indirect taxes (like VAT) at all. How this will be applied in the context of the U.S.-UK double tax treaty is not clear.

Conclusion

Given both the uncertainty regarding the intricacies and workings of the BAT as well as how it will interact with existing Double Tax Treaties, the introduction and operation of the BAT remains unclear

The impact of the proposed tax on net importers vs net exporters divides the business community and creates further uncertainty in an already uncertain economy. The same applies to the consequences on the application and interpretation of domestic tax and international tax law outside the U.S. It is hoped that detailed legislation as well as commentary addressing the concerns of the U.S. domestic and international community will go some way in resolving these issues in a time efficient manner.

Copyright 2017 K & L Gates

NAFTA and the New Trump Administration: Your Top Ten Questions Answered

With the recent U.S. election finally reaching its close, the unexpected election of Mr. Trump has left many multinational companies wondering how the change in administration will impact their business operations. One of the chief issues of concern is Mr. Trump’s campaign rhetoric that the United States should withdraw from the North American Free Trade Agreement (NAFTA) or, perhaps, substantially renegotiate it (with Mr. Trump taking both positions at times).

Many multinational companies have structured their operations on the assumption that the free trade of goods within the NAFTA region was a given, and understandably are nervous regarding the future of the agreement. To help deal with this insecurity, this client alert presents the “top ten” questions every company that relies on NAFTA should be thinking about. Future client alerts will deal comprehensively with all international trade and regulatory areas where significant change could occur under the new administration.

The Top 10 NAFTA Questions

1. What has President-elect Trump promised?

2. Is the promised repeal of NAFTA a real possibility or just campaign rhetoric?

3. Can the Trump administration just withdraw from NAFTA on its own?

4. Will Congress have any role in the withdrawal or be able to alter the way in which any withdrawal occurs?

5 .What are the most likely options — withdrawal, amendment, or no change?

6. Are there limits to how high tariffs could go if there is a full withdrawal?

7. If there is a full withdrawal, what will be the consequences in addition to higher tariffs?

8. Are there countries other than Mexico that are potentially a target for major changes in U.S. trade policy?

9. If NAFTA withdrawal is part of a “war on international trade,” what are some other types of international trade issues I should be monitoring?

10. The possibilities sound pretty scary. What can my company do to help mitigate the risk of a NAFTA exit?

The Top Ten NAFTA Questions Answered (or, What to Do If the New Administration Plays the NAFTA Trump Card)

1. What has President-elect Trump promised?

After calling NAFTA “the worst trade deal maybe ever signed anywhere,”1 Mr. Trump stated that he either would seek a full repeal of the agreement or would seek to renegotiate it to remove incentives to transfer manufacturing and jobs to Mexico. Mr. Trump’s “100-day action plan to Make America Great Again” confirmed that NAFTA would be a focus of the early days of the administration, as it promised that within 100 days of taking office, Mr. Trump would “announce my intention to renegotiate NAFTA or withdraw from the deal under Article 2205.”2 Action on NAFTA likely will be a priority of the Trump administration.

2. Is the promised repeal of NAFTA a real possibility or just campaign rhetoric?

The election of Mr. Trump ran straight through such manufacturing states as Wisconsin, Ohio, and Pennsylvania. In each of these states, anger about lost manufacturing jobs, and their often high wages, was a deciding factor for key swing voters. It is fair to say that discontent about the loss of manufacturing jobs in general, and the accompanying anger with NAFTA in particular, likely tipped these closely contested states — and therefore the election — to Mr. Trump.

With the high visibility given to NAFTA, it is highly likely that there will be either a NAFTA withdrawal or at least enough of a renegotiation of its terms that Mr. Trump can claim that his administration has “fixed” NAFTA. Certainly the Mexican and Canadian governments believe Mr. Trump is serious: Leaders of both countries have stated they are open to renegotiating the terms of NAFTA, although Mexico stated its willingness was more along the lines of having a “discussion” of potential changes.3

3. Can the Trump administration just withdraw from NAFTA on its own?

Article 2205 of NAFTA provides that “{a} party may withdraw from this Agreement six months after it provides written notice of withdrawal to the other Parties. If a Party withdraws, the Agreement shall remain in force for the remaining Parties.” Thus, withdrawal could potentially be effective as early as the summer of 2017. In all likelihood, however, there would initially be a period where renegotiation is attempted, thus delaying any unilateral withdrawal. The likelihood of a withdrawal by this summer accordingly is very small. Further, as noted below, duties would not change for likely a year or more after any withdrawal occurs.

4. Will Congress have any role in the withdrawal or be able to alter the way in which any withdrawal occurs?

Although NAFTA was approved by Congress, it is technically not a treaty. Rather, it is a congressional-executive agreement approved by a majority vote of each house of Congress, as are the World Trade Organization (WTO) agreements). NAFTA was put in place pursuant to the Trade Act of 1974, which gives the president authority to negotiate agreements dealing with tariff and non-tariff barriers. Section 125 of the 1974 act gives the right to terminate and withdraw solely to the president, after giving appropriate notice (six months, as specified in NAFTA).4

5 .What are the most likely options — withdrawal, amendment, or no change?

Although Mr. Trump has repeatedly criticized NAFTA (as well as other trade agreements, such as the WTO agreements), he did not state that he was against all trade agreements. Instead, he stated his view that many existing free trade agreements (FTAs) were poorly negotiated, and thus were not in the interest of the United States and U.S. manufacturers. This position opens up several possibilities regarding NAFTA, ranging from complete withdrawal to severe or even moderate renegotiation. The criticism of NAFTA thus could be used as a way of creating negotiating leverage to allow for the targeted reopening of the agreement.

Despite the campaign rhetoric, millions of U.S. jobs depend on trade between the United States, Canada, and Mexico. Canada and Mexico are, respectively, the first and second largest export markets for the United States. (Although China is a larger overall trading partner, China trade is heavily weighted towards exports to the United States.)5 Much of the trade with Mexico, in particular, involves the shipment of U.S. goods to Mexico for assembly and then the return of the downstream products to the United States. Eliminating NAFTA without any replacement would create tremendous upheaval in these international supply chains. This would lead to significant job losses in the short term and the stranding of significant investments that were made based on the promise of free trade benefits.

As a result, impacted companies likely will exert tremendous pressure on Mr. Trump to amend, rather than repeal, NAFTA. Significant changes to NAFTA would support Mr. Trump’s claim that business negotiators would be able to achieve better FTAs than “career diplomats,” while still allowing him to claim that he has carried through on his NAFTA promises.

There are also strong reasons on the partner side to believe that renegotiation, rather than withdrawal, is most likely to occur. Since Canada shares concerns about the transfer of jobs to Mexico, it would not be surprising if Canada were to align with the United States on certain issues that it would prefer to see amended. As for Mexico, NAFTA is too important to the Mexican economy for Mexico to give up its free trade access to the United States without a fight. Even if Mexico would prefer that the agreement remain as written, giving up trade concessions would be far preferable to risking the likely recession and economic upheaval that would accompany withdrawal and the shift of U.S. multinational companies to other locations.

The effect of NAFTA withdrawal also could have the side effect of increasing illegal immigration — another Trump signature issue. Upheaval in the Mexican economy and any recession as a result would almost certainly lead to an increased desire for Mexican workers to leave Mexico for the much stronger U.S. economy. Avoiding a large increase in illegal immigration from Mexico (which actually has been falling in recent years) may pressure Mr. Trump to amend, rather than eliminate, NAFTA.

6. Are there limits to how high tariffs could go if there is a full withdrawal?

As a general matter, the Trade Act of 1974 provides that after any withdrawal from a covered agreement, impacted tariff rates will remain unchanged for one year. This is to allow businesses time to adjust to any change. The president is allowed to raise tariffs more quickly if there is a need for expeditious action, so long as Congress is notified and a public hearing is held, but this option is unlikely to be triggered.6 Thus, for all intents and purposes, there will be no increase in tariffs for at least 18 months (the six-month notice period plus the additional year of frozen duty rates).

Beyond that, if the United States withdraws from NAFTA, there are two sets of default options that come into play. The U.S.-Canada Free Trade Agreement — which preceded NAFTA — is still in effect, as it was only suspended when NAFTA came into force. So withdrawal from NAFTA would likely bring the U.S.-Canada FTA back into play. Although not automatic, reinstatement of that U.S.-Canada FTA likely would be politically acceptable, both because Mr. Trump did not focus any attention on Canada in particular when criticizing NAFTA, and because the trade deficit with Canada itself is quite small when compared to the deficit with Mexico. Further, with Canada often exporting natural resources such as petroleum to the United States, its exports are not viewed as displacing U.S. manufacturing jobs. Indeed, with there being some concern in Canada that its own manufacturing base has been hollowed out in recent years, Canada might even join the United States in seeking certain modifications to NAFTA.

If the U.S.-Canada FTA is brought out of suspension, trade between the two countries may be a lot like it is under NAFTA. The tariff rates under the U.S.-Canada FTA are often the same as the rates under the NAFTA (i.e., often zero). The U.S.-Canada FTA also includes many of the same types of FTA protections as contained in NAFTA, such as providing the means of appealing disputes to special arbitrator panels. Thus, the impact of repeal with regard to dealings with Canada is limited because the fallback position is another FTA.

It is trade with Mexico that could potentially see more changes. NAFTA is the only FTA possibility in place between the United States and Mexico. Without any type of FTA in place, the tariffs between the United States and Mexico would be based on pre-NAFTA levels. The extent of the rise is dictated by two different legal documents:

  • Under U.S. law, tariffs are allowed to rise to a level that is between 20 and 50 percent higher than the rates in effect on January 1, 1975.7 Because tariff rates were much higher in 1975, this would allow for very large tariff increases.

  • This degree of increase would not occur, however, because the extent of any increase in tariffs is limited by the WTO agreements, which are multilateral agreements that are independent of NAFTA. Due to the operation of the most favored nation (MFN) tariff rules, tariffs for Mexico and the United States would be set based upon the average tariff rates in place for each country. The United States has a low MFN rate, which means that even though U.S. law otherwise allows for large increases based on 1975 tariff levels, existing WTO rules would limit the increase to a general maximum of 3.5 percent.

The irony is that the increase in Mexican tariffs would be much greater than 3.5 percent. The Mexico MFN rate is much higher than the U.S. rate, meaning that Mexican duties could increase to as much as 36 percent. This means that the tariff impact of NAFTA withdrawal would actually be felt more acutely on the U.S. side of the border, as the rate levied by Mexico on exports from the United States would rise to a much greater degree than the rate that could be levied by U.S. Customs & Border Patrol on imports from Mexico. Withdrawal, supposedly intended to aid U.S. manufacturing, would asymmetrically result in much higher tariffs for U.S. exports.

7. If there is a full withdrawal, what will be the consequences in addition to higher tariffs?

Including negotiated annexes, NAFTA is more than 2,000 pages long. In addition to a full phase-out of tariffs, NAFTA also eliminated a variety of non-tariff barriers (import licenses, local-content requirements, export-performance requirements, and other non-tariff barriers). NAFTA helped unify customs procedures and regulations, provided uniform investment rules, established fair and open procurement procedures, and gave firms the right to repatriate profits and capital, among other trade and investment provisions. It also provided a mechanism for settlement of many bilateral disputes. All of these investments in trade stability could disappear if NAFTA is no longer in force.

Another wild card is the impact of any withdrawal of the maquiladora rules. The maquiladora rules pre-date NAFTA, and provide for special tariff rates and other advantages for companies in the maquiladora region (generally, within 75 miles of the U.S. border, although they can be located elsewhere). Such industries as the automotive, aerospace, medical devices, and electronics industries have turned the maquiladora region into a sophisticated manufacturing hub, making maquiladora operations essential parts of the complex supply chains established by U.S. companies that operate within this region. There was no discussion of the maquiladora special tariffs during the campaign, and it is unknown whether there will be any changes in these rules. Although it is a program run by Mexico, its growth in use has been spurred by NAFTA, and the United States has cooperated in many aspects of the maquiladora program. It is unknown whether the rules will change in light of any NAFTA modifications or withdrawal.

8. Are there countries other than Mexico that are potentially a target for major changes in U.S. trade policy?

Equal to the criticisms of NAFTA (which are largely criticisms of trade with Mexico, not Canada) were criticisms of China. China is a juicy target for campaign rhetoric, since it not only is a large trade partner, but also is a country that frequently exports while importing far less. Far more manufacturing jobs depend on exports to Mexico than to exports to China.

The 100-day plan states that Mr. Trump will “direct my Secretary of the Treasury to label China a currency manipulator.”8 This designation takes advantage of a law passed this year that allows for retaliation against countries that manipulate currencies to give their goods an artificial advantage. Any such designation might be accompanied by other actions against China, such as designating currency manipulation as a countervailable subsidy in countervailing duty investigations and administrative reviews or taking action against Chinese imports in other ways, such as through safeguard actions. Mr. Trump’s 7-Point Plan to Rebuild the American Economy by Fighting for Free Trade also vowed to raise tariffs on Chinese imports and to bring cases against China for any violations of international trade agreements, as well as to incorporate the campaign promise to label China a currency manipulator.9

China also is not a member of any FTA with the United States, and thus is reliant on its membership in the WTO to provide what trade protections are available to it. Any attempts to lower the trade deficit have to include China, as trade with China represents more than 40 percent of the overall trade deficit.10 Yet proposals by Mr. Trump to place high tariffs on imports from China likely would run afoul of WTO rules, which may mean that fights against Chinese imports need to take place using international trade litigation (described below).

Looking past China and Mexico, there are three other countries with significant trade deficits with the United States: Japan, South Korea, and Germany. None of these countries was singled out the way Mexico and China were during the campaign; nonetheless, the trade deficit represented by these countries is also significant. There is a heightened probability that these countries will, at the very least, be singled out through such international trade remedies as antidumping, countervailing duty, and safeguard actions, as discussed below.

9. If NAFTA withdrawal is part of a “war on international trade,” what are some other types of international trade issues I should be monitoring?

Regardless of whether NAFTA is terminated, there is a wide variety of international trade actions that can be taken to limit the amount of imports from Canada, Mexico, and other countries that are not parties to NAFTA. These include:

  • Section 301 proceedings. Section 301 of the Trade Act of 1974 gives the U.S. trade representative, at the direction of the president, the ability to impose tariffs based on “an act, policy, or practice of a foreign country that is unreasonable or discriminatory and burdens or restricts U.S. commerce.” One of the remedies that can be imposed is higher tariffs on imports from a chosen country.

  • Section 122 balance-of-payment proceedings. Section 122 of the Trade Act of 1974 authorizes the president to deal with “large and serious United States balance-of-payments deficits” by imposing temporary import surcharges or temporary quotas or a combination of both. This relief is limited and temporary, however, as it can only last 150 days, and the charge cannot exceed 15 percent of the ad valorem value of the imported goods.

  • Section 232(b) national security actions. Where there is a deemed threat to national security, Section 232(b) of the Trade Expansion Act of 1962 authorizes the secretary of commerce to investigate imports and then take actions to limit or restrict them, or to “take such other actions as the president deems necessary to adjust the imports of such articles so that such imports will not threaten to impair the national security.”

  • International trade remedies (safeguard proceedings and antidumping/countervailing duty investigations). These forms of international trade remedies focus on relief for individual products, types of products, or industries. They do not provide the same type of general relief as afforded by a wholesale increase in customs duties, but can offer powerful relief in a more targeted fashion. Duties in antidumping and countervailing duty proceedings often exceed 10 – 20 percent of the entered value of subject merchandise (depending upon the information submitted in lengthy and detailed questionnaire submissions). If non-U.S. companies do not respond to the detailed requests for information, the duties imposed are based upon “facts available,” which is intended to be punitive and can result in duties that exceed the value of the goods themselves by more than 100 percent. Safeguard proceedings can result in targeted duties on entire industries as well.

  • Section 337 unfair trade practices proceedings. These proceedings target unfair trade practices, including the abuse of patent and trademark rights. In some recent cases, U.S. companies have created novel theories that would allow the International Trade Commission to reach a wide variety of conduct, thereby expanding the use of the section 337 process to address perceived unfair trade practices.

The potential increase in international trade remedies is a complicated subject in and of itself. This is especially true for certain industries of concern to Mexico and Canada, such as the steel and softwood lumber industries. (In this regard, antidumping and countervailing duty petitions on softwood lumber from Canada were filed on November 25, 2016.) This topic will be explored in a future client alert devoted to international trade remedies under the Trump administration.

10. The possibilities sound pretty scary. What can my company do to help mitigate the risk of a NAFTA exit?

As noted above, there is a wide set of possibilities, ranging from moderate (or even no) change to complete revocation of the agreement. Predicting the exact impact of any change to NAFTA can be difficult. Multinational corporations with operations in Mexico should, however, consider the following topics when determining how best to cope with the uncertainty of a potential NAFTA exit:

  • Customs Issues
    • Assess which party is the importer of record. Because of the absence of duties, many companies in the NAFTA region paid little attention to which company acts as the importer of record. Because the importer of record is responsible for the payment of duties, a review of the entity that is acting as the importer of record, and assessing whether this arrangement makes sense in a post-NAFTA world, could help avoid unpleasant surprises.

    • Assess whether processing outside the customs territory can be used. Depending on which way the trade is occurring and the form of the transaction, there are various types of warehousing and manufacturing options that are deemed to be outside the customs territory of the country at issue, such as through the use of foreign trade zones (FTZs). Goods that are in an FTZ are considered not to have entered into the customs territory of the country, thus delaying any payment of duties. If the goods are later shipped to a different country — even the originating country — then no duties are ever paid, even if the goods were further manufactured while in the FTZ. This is a valid option to consider for goods that require processing before they are shipped to another country or back to the originating country.

    • Assess whether other customs options exist. In addition to FTZs, there are additional options for goods that can delay or eliminate duties, including the use of customs bonded warehouses or Temporary Importation Under Bond. Such options become more valuable if NAFTA tariff relief is eliminated.

    • Assess whether refunds of duties are possible. For goods that are involved in a round trip, there can be options where duty refunds can occur, including the use of the American Goods Returned program (where the goods are not further improved while abroad), Mexican and U.S. duty drawback procedures, and other refund programs. Eligibility can vary and depends upon the exact form of the importation pattern.

    • Determine if all customs valuation options are being used. When the tariff rate is zero, the precise value of the goods entered is of little moment. But in a tariff environment, strategies such as the first-sale doctrine (which allows for value to be entered based on the first sale to a middle man, rather than the final price) become more valuable as a means of minimizing duties.

  • Supply Chain Options
    • Assess the supply base and what alternatives exist. Companies that have the option of using NAFTA generally have found Mexico to be the cheapest option, due not only to NAFTA regional preferences, but also due to inexpensive transportation options between the two countries. Companies should assess whether Mexico-sourcing still makes sense in a post-NAFTA world, and be prepared with a contingency plan if NAFTA exit becomes a reality. Options would include taking advantage of other FTAs, reshoring manufacturing options, or some of the other customs alternatives outlined above.

    • Assess maquiladora manufacturing options. NAFTA withdrawal might not impact all operations equally, due to the fact that the maquiladora benefits (which are granted by Mexico) will likely remain. The benefits of the maquiladora program include the ability to temporarily import goods and services that will be manufactured, transformed, or repaired, and then re-exported back to the United States, without paying taxes, being subject to compensatory quotas, and other designated benefits. For companies whose operations qualify, these benefits may make continuing Mexican operations profitable, even if duties increase. Companies that are not taking advantage of these cost-saving opportunities might want to consider them as a means of potentially offsetting some measure of any increased tariffs.

  • Political Options
    • Consider seeking miscellaneous tariff bill options. From time to time, Congress passes a Miscellaneous Tariff Bill (MTB), which allows for the grant of customs duty forbearance for specific products. Companies that operate in Mexico have not needed to pay attention to this repeated Washington rite, because their products already enjoyed duty-free status. In a post-NAFTA world, the MTB might become an option worth monitoring and pursuing for products that meet the requirements for consideration.11

    • Consider options for political pressure. NAFTA represents a trillion dollars of annual bilateral trade. Any actions to up-end that arrangement are going to be contentious, heavily lobbied, and feature winners and losers. Companies that are part of well-connected industries and trade associations will be able to enhance their ability to come out on top if the agreement is renegotiated.

  • International Trade Litigation Issues
    • Assess if trade litigation is likely to impact important products and inputs. Regardless of how NAFTA changes, the likelihood of increased trade frictions in the form of international trade litigation is highly likely. Antidumping and countervailing duty actions are likely to increase in the new administration, as potentially will Section 337 and safeguard actions. To deal with this possibility, companies that deal with goods from other countries, including Canada and Mexico, should consider monitoring rumors of potential filings, assessing whether important goods are in industries where trade actions are common (steel products, chemicals), products where there are rumors regarding potential filings (various steel products, softwood lumber from Canada, and so forth), and monitoring whether imports are of products where imports have been sharply rising, especially if at low prices. Import trends can be monitored for any Harmonized Tariff System number on the website of the International Trade Commission.12

    • Consider going on offense. It is widely anticipated that the new administration will be more receptive to the filing of antidumping and countervailing duty actions, safeguard proceedings, and other forms of international trade remedies. If a case can be made that products are being sold at low prices in the United States by foreign producers or are receiving subsidies, and these imports are causing material injury to the U.S. industry producing the same product, it may make sense to consider filing a petition to seek import relief. Questionnaires to help assess whether such an action has a potential basis are available by contacting the author at the contact information listed at the end of this alert.

The issues outlined in this alert are only the tip of the international trade iceberg. Companies that have significant operations that could be impacted by the potential NAFTA changes should consider lining up counsel to monitor ongoing developments in the area, suggest coping strategies, and take other measures to mitigate the risk of a NAFTA exit. Billions of dollars of exports, and millions of manufacturing jobs, will be impacted based on how the NAFTA withdrawal/renegotiation is handled. With that much money at stake, it behooves companies with operations, sales, imports, and exports that depend on or are impacted by NAFTA to closely monitor any changes in the Agreement.


1 See http://money.cnn.com/2016/09/27/news/economy/donald-trump-nafta-hillary-clinton-debate/?iid=EL.

2 See https://assets.donaldjtrump.com/_landings/contract/O-TRU-102316-Contractv02.pdf.

3 See http://abcnews.go.com/International/wireStory/canadian-immigration-website-crashes-amid-trump-victory-43413321 and https://www.yahoo.com/news/mexico-says-ready-modernize-nafta-trump-181527988.html.

4 NAFTA was negotiated under the fast-track authority of the Omnibus Trade and Tariff Act of 1988, which made the termination and withdrawal provisions of Section 125 of the 1974 Act applicable to NAFTA.

5 See https://www.census.gov/foreign-trade/statistics/highlights/top/top1312yr.html.

6 See Trade Act of 1974, Public Law 93-618 as amended), P.L. 114-125, § 125 (available at https://legcounsel.house.gov/Comps/93-618.pdf).

7 See Trade Act of 1974, Public Law 93-618 as amended), P.L. 114-125, § 125(c) (available at https://legcounsel.house.gov/Comps/93-618.pdf).

8 See https://assets.donaldjtrump.com/_landings/contract/O-TRU-102316-Contractv02.pdf.

9 See https://www.donaldjtrump.com/policies/trade.

10 See https://www.census.gov/foreign-trade/statistics/highlights/top/top1312yr.html.

11 See The International Trade Commission, Miscellaneous Tariff Bill Petition System (MTBPS) (available at https://mtbps.usitc.gov/external/).

12 See https://dataweb.usitc.gov/.

Elections 2016, Trans Pacific Partnership, TTIP: Trade Talk 7-13 November 2016

meting trade globe  Trans Pacific PartnershipDonald Trump won the U.S. presidential election against former Secretary of State Hillary Clinton on 8 November in what many are describing as an upset. President-Elect Trump’s transition team is now tasked with vetting possible Cabinet officials and lower-level appointees, receiving background briefings from the Obama Administration, and crafting policy proposals based on his campaign promises.  President-Elect Trump will be sworn-in as the 45th President of the United States on 20 January.

TPP – No-Go.  President-Elect Trump remains opposed to the TPP agreement in its current form, and lawmakers on both sides of the aisle continue to express concerns with certain issues in the final deal that reportedly have not yet been addressed by the Obama Administration. Ongoing concerns with the TPP deal include longer intellectual property protections for biologic drugs and concerns with the tobacco industry’s carve-out from the deal’s investor-state dispute resolution mechanism. Shortly after the elections, Republican Congressional leaders in both chambers issued statements indicating the deal will not be brought up for a vote before the end of 2016 and must be revisited after President-Elect Trump takes office. According to a draft 100-day plan leaked by Politico, Trump advisors are proposing the U.S. withdraw from the deal soon after Trump takes office – however, other TPP countries are likely to keep advocating for the deal with the next Administration.

TTIP – On Hold.  With the uncertainty surrounding President-Elect Trump’s trade priorities, European Union Trade Commissioner Cecilia Malmström said of the Transatlantic Trade and Investment Partnership (TTIP) negotiations on 11 November:

For quite some time TTIP will be in the freezer. What happens when it’s defrosted, I think we’ll have to wait and see.”

The EU and United States are not expecting to schedule any more formal negotiating rounds this year.

JCCT Meeting Ahead.  U.S. Secretary of Commerce Penny Pritzker and U.S. Trade Representative Michael Froman will host the 27th session of the U.S.-China Joint Commission on Commerce and Trade (JCCT) next week in Washington.  Vice Premier of the State Council Wang Yang will lead the Chinese delegation.  U.S. Secretary of Agriculture Tom Vilsack is also expected to join the JCCT meeting to address bilateral agricultural trade issues.  President-Elect Trump made it clear during the campaign that China’s perceived unfair trade practices will be addressed in his Administration, including labeling the country as a currency manipulator.

© Copyright 2016 Squire Patton Boggs (US) LLP