The Proliferating FTAs: They Can Help or Hurt You

1. The Proliferating FTAs:They Can Help or Hurt You New York, NY April 6, 2006 H. Douglas Garfield Director, Global Customs & Trade PepsiCo International

2. A key goal for multinational companies is to optimize their global sourcing and minimize their all-in go-to-market costs. Witness Wal-Mart, Home Depot, etc. Reducing manufacturing and selling costs are key, but so are reducing other costs, including income and other taxes, duties, market access barriers, etc. The proliferation of FTAs worldwide creates opportunities to review sourcing and manufacturing location decisions to further optimize costs and service regional markets from single locations. Maximizing FTA Opportunities 2

3. Some Key Drivers for Global Sourcing Optimization Duty Reductions (FTA benefit) Tax Savings (locating in low tax jurisdictions) Market Access (FTA benefit) Commercial (e.g., CAPEX) Logistics (regional sourcing) Maximizing FTA Opportunities 3

4. But capitalizing on FTA benefits requires significant advance planning and due diligence Investigation of candidate sourcing locations for potential benefits Risk assessment regarding political and economic stability, ability to conduct business, relations with key external markets Examination of specific FTA benefits sought and requirements to qualify (e.g., rules of origin) Maximizing FTA Opportunities 4

5. Ideally, the advance planning begins before the FTA has even been negotiated and finalized Lobbying efforts can be particularly effective in positioning an FTA so as to benefit your company Tariff reduction schedule Immediate elimination vs. longer term phase-outs Rules of Origin Tailored to your particular business and/or products Other barriers and/or fees E.g., addressing uncapped “customs processing fees” Proactively Influencing Trade Negotiations 5

6. Companies need to make their positions known to USTR (or its foreign country equivalent) Be able to articulate the problem. Details count! Identify allies within the relevant governmental bodies On both sides of the FTA Proactively Influencing Trade Negotiations 6

7. Advance planning and diligence is also critical to achieving benefits once the FTA is in force Understanding the specific requirements for qualification under the applicable FTA Understanding the particulars of your business operations Understanding and successfully meeting the challenges of FTA eligibility substantiation and documentation requirements Understanding and adapting to the political and/or cultural environment in which you are seeking to operate Maximizing FTA Opportunities 7

8. Rules of Origin The key to FTA eligibility There are many different rules of origin, depending upon the FTA and/or the product Examples Tariff Shift Rule (Most commonly used) Regional Value Content (“RVC”) Transaction Value Method Net Cost Method Substantial Transformation Alternative ROOs (e.g., chemical reaction, or controlled mixing/blending rules) Knowing the FTA Eligibility Rules 8

9. FTA origin rules can be very complex and can contain additional restrictions and/or provide additional opportunities Examples Non-qualifying operations/activities (e.g., mere dilution, repackaging, unitizing) Expansive carve-outs from tariff shift (e.g., key ingredients/components) Limitations on use of Transaction Value for RVC Substantial related party sales of similar/identical goods Limited to Net Cost RVC RVC Averaging – for goods falling under same HTS subheading Note: Not limited to one ROO per FTA Can use different ROOs for different product flows Knowing the FTA Eligibility Rules 9

10. FTA eligibility is influenced by a multitude of business factors that, with proper planning, can be “tweaked” in order to attain (or avoid) a particular FTA outcome, Manufacturing processes/activity R&D/product formulation Material & ingredient sourcing/procurement Knowing Your Business Operations 10

11. Each of these (and many other) business factors have a direct impact on whether a particular product will qualify for preferential treatment under the FTA’s rules of origin For these reasons, intra-departmental communication and coordination is key to efficient implementation of FTA-based sourcing It is not simply a Customs or Logistics Dept. undertaking Knowing Your Business Operations 11

12. Some of the business functions critical to a successful FTA undertaking Procurement Re: ingredient origin, classification and valuation Operations Re: substantial transformation/processing activity R&D Re: substantial transformation/processing activity Finance/Tax Re: pricing/valuation, RVC, de minimis Government Affairs Re: FTA negotiations Knowing Your Business Operations 12

13. Origin Certification Procedures: The “Front End” Exporter self-certification (e.g., NAFTA) Certification by authorized entities/institutions Must satisfy diligence standard of external body Sworn Declaration of Origin for each product, including Detailed material/ingredient information Description of manufacturing/productive process Knowing the Substantiation Requirements 13

14. Tension: Between certifying entity’s “need to know” and the company’s “need to protect” proprietary formula information Solution: Provide limited ingredient/formula information, supported by supplemental product/ingredient affidavits Compromise, built on trust and developed through negotiation Knowing the Substantiation Requirements 14

15. Origin Verification: The “Back End” A certificate of origin is not “bullet proof” Whether issued by the exporter or by an authorized entity of the exporting country, a COO is subject to verification by the country of import “Must Haves” in the event of an origin verification audit/inquiry: Must know the correct classification of the exported finished good Is there (dis)harmony between the export/import countries? Must know correct classification of each component/ingredient used to produce the exported finished good Knowing the Substantiation Requirements 15

16. Origin Verification “Must Haves” (cont’d) Must maintain supplier certifications, where appropriate E.g., for ingredients that do not tariff shift but which originate from one of the member countries Must maintain accurate bills of materials (“BOMs”) for each exported finished good Including accurate component/ingredient cost Must maintain source documents to support origin claim E.g., invoices, import declarations for components/ingredients Must have documented processes and controls So as to demonstrate understanding and satisfaction of the rules of origin Knowing the Substantiation Requirements 16

17. Knowing the rules and knowing your business is not enough to succeed in the FTA arena Understanding the political and cultural climate in both the export and import countries is critical to achieving success Local customs and practices Governmental agencies Service providers (e.g., customs brokers) Knowing the Political & Cultural Landscape 17

18. Particularly where certification authority is vested in a local entity, it is imperative to ascertain how best to interface with such entity Consult with local business team Consult with local advisors Be cognizant of impact that “outsiders” can have on the process Knowing the Political & Cultural Landscape 18

19. Utilizing a new FTA for new product flows is an ongoing exercise of mutual learning and trust-building between the authorities and the exporter and/or importer Introduction of new and/or unfamiliar concepts to satisfy origin takes time and patience RVC – had never been used before Averaging – the FTA was skimpy on details New perspectives on the quantum and quality of information to be provided in seeking COOs Educating the authorities as to your company’s products and processes Lessons Learned 19

20. Devoting sufficient human, capital and systems resources to FTA origin compliance is a “must do” FTA origin management is an extremely data and document-intensive exercise Burden of proof to establish that origin criteria has been satisfied is on the exporter and/or importer High profile companies are charged with high expectations for delivering solid, reliable data and documentation Attention to detail is critical! Missing, misstated or inconsistent information can delay or negate FTA preference benefits Mistakes can also destroy credibility and goodwill Lessons Learned 20