Report of the Foreign Affairs, Defence and Trade Committee

International treaty examinations of the Exchange of Letters Constituting an Agreement to Amend Article 3 (Rules of Origin) of the Australia New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) and of the Agreement to Amend the Product Specific Rules in Annex G of the ANZCERTA Recommendation The Foreign Affairs, Defence and Trade Committee has conducted international treaty examinations of the Exchange of Letters Constituting an Agreement to Amend Article 3 (Rules of Origin) of the Australia New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) and of the Agreement to Amend the Product Specific Rules in Annex G of the ANZCERTA, and recommends that the House take note of its report. Background The Australia New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) entered into force on 1 January 1983. The rules of origin pertaining to ANZCERTA were revised in 2005/06 and changed to implement a change in tariff classification method, which recognised the production of a product undertaken by the trading party regardless of the origin of inputs. These revised rules entered into force on 1 January 2007. Provision was made to review them within three years to address any issues arising from their implementation and to ensure their relevancy in the wider context of each country s agreements with other trading partners. Accordingly, the rules were reviewed in early 2010. Rules of origin Under Article 3 of ANZCERTA, the rules of origin are designed to protect the integrity of free trade between New Zealand and Australia by preventing exporters in other countries from shipping their product through one party to get preferential access to the market of the other. The rules of origin determine which products count as Australian or New Zealand and are thus eligible to enter the markets in either country at a zero tariff. Changes to rules of origin Negotiations regarding Article 3 of ANZCERTA have resulted in several changes. The main changes set out to simplify the tariff classification rules and remove most of the dual requirements regarding products that need to meet both a tariff requirement and a regional value content threshold. These changes mainly affect the regional value content of textiles, apparel, carpets, and made up textile articles. 2

We are satisfied that the proposed changes to the rules of origin would facilitate trans- Tasman trade, resulting in economic gains to both countries and advancing their integration into a single economic market. They would also reduce compliance costs deriving from the rules of origin governing trans-tasman trade. Furthermore, they would bring the ANZCERTA rules of origin into line with other free trade agreements concluded since 2007 by Australia and New Zealand with other trading partners, particularly the Agreement Establishing the ASEAN Australia New Zealand Free Trade Area. Implementation We note that the proposed rules would enter into force when New Zealand and Australia had aligned and completed their domestic legislative processes. New Zealand s domestic process will occur in two stages, the first involving the making of regulations to implement Annex G, the second the passage of legislation to implement Article 3. Related matters We have widened our examination of the international treaty examination of the amendments to ANZCERTA to include consideration of the effect of rules of origin on the capacity and ability of South Pacific Island countries and exporters to trade with Australia and New Zealand, with particular reference to the South Pacific Regional Trade and Economic Cooperation Agreement (SPARTECA). We understand that the SPARTECA rules of origin have remained largely unchanged since the agreement was signed in 1981, and that requests have been made to change the rules. The value of the rules of origin preferences in SPARTECA are being eroded by changes to the global economy and particularly the increasing use of integrated global commodity chains in the production of manufactured goods. The value-added component of the rules of origin is becoming both technically and practically difficult to meet. Changes to the rules of origin will be addressed in the negotiations of the Pacific Agreement on Closer Economic Relations Plus (PACER Plus). However, these negotiations face challenges. We understand that New Zealand, Australia, and Pacific Island countries are discussing ways to improve the rules of origin to facilitate trade for Pacific Island countries and exporters but the issues facing them need to be clarified. We note that the tariff rates on goods imported into New Zealand or Australia are low. We recommend that the New Zealand Government continue to engage with their Australian counterparts to make the necessary changes to the rules of origin pertaining to SPARTECA while negotiations regarding PACER Plus continue. These changes could then be included in the final PACER Plus agreement. We believe that changes to these rules could lead to certainty of access to Australian and New Zealand markets for the South Pacific Island countries, and thus improve their economic prosperity. Conclusion We have conducted an examination of the treaties and believe that the revised ANZCERTA rules reflect the realities of regional and global supply chains and manufacturing processes. The revised rules would enhance trade and economic growth opportunities for New Zealand businesses in the trans-tasman market. 3

Appendix A Committee procedure The committee called for public submissions on the treaties. The closing date for submissions was 15 July 2010. The committee received and heard one submission. The committee met between 24 June and 29 July to consider the treaties. Committee members John Hayes (Chairperson) Hon Chris Carter (until 21 July 2010) Jacqui Dean Hone Harawira (non-voting member) Hon Pete Hodgson Dr Paul Hutchison Keith Locke Todd McClay Hon Maryan Street Phil Twyford (from 21 July 2010) 4

Appendix B Amendment of Article 3 of the Australia New Zealand Closer Economic Relations Trade Agreement - Rules of Origin National Interest Analysis Executive summary 1 Rules of Origin (ROO) are the means by which goods qualify for preferential tariff rates under free trade agreements (including, for Australia and New Zealand, under the Australia New Zealand Closer Economic Relations Trade Agreement (ANZCERTA)). 2 A major revision of the ANZCERTA rules of origin was undertaken in 2005/06 to allow a move from the traditional regional value content approach to rules of origin to a change in tariff classification approach 1. The new rules entered into force on 1 January 2007. 3 Review provisions were written into the amended Article 3 of ANZCERTA to accommodate an early review of the new rules, particularly in those areas that retained an added value component. The major proposals arising from the review provide for: the immediate removal of supplementary added value requirements across a range of products but in particular for textile, clothing and carpet product lines; the removal of added value requirements for men s and boys structured apparel of tariff heading 6203 in 2012; the addition of alternative rules for textile products which allow the combined processes of printing/dyeing and finishing to confer origin; the removal of complex exclusions from some change in tariff classification rules; and the addition of new minimal processes for which origin cannot be claimed. 4 The proposed amendments to Article 3 will simplify the existing rules and will consist primarily of a simple change in tariff classification rule, or where desirable, an alternate regional value content rule based on a free on board (FOB) calculation. The revisions ensure that the ANZCERTA rules of origin continue to reflect the realities of regional and global supply chain manufacturing processes. New Zealand (and Australian) firms will more easily be able to meet rules of origin and/or face less compliance costs in establishing compliance with the origin rules governing trans-tasman trade. 1 1 Under a change in tariff classification (CTC) approach, origin is conferred if the non-originating materials used in the production of a good have undergone a specified change in tariff classification within the territory of the parties. For example origin is conferred when imported third party cotton fabric of tariff heading 5208 is transformed into a woman s shirt of tariff heading 6206. Under a regional value content (RVC) approach, origin is conferred if the value added within the territory of the parties meets a specified threshold (for example 40%). 5

5 The impact of the changes to the rules will be to facilitate greater trans-tasman trade, bringing economic gains for both countries from trade and in turn enhance Single Economic Market integration. Competitive adjustment impacts on business are not likely to be significant, because while the potential change in tariff levels is in the order of 5% 10%, many New Zealand and Australian textile and apparel exports already meet the current more onerous origin requirements and enter each others markets duty free. Also, New Zealand firms will tend to gain more from the shift to the change in tariff classification approach, as the regional value approach favours firms in economies with higher labour costs. There will be a small fiscal cost in term of forgone tariff revenues and there will be minor transition adjustment costs for business in moving from the complex regional value compliance regime to a change in tariff classification approach. 6 The revised rules also bring the CER ROO into line with other free trade agreements concluded since 2007 by both Australia and New Zealand with other trading partners, and in particular with the joint undertaking in the Agreement Establishing the ASEAN Australia New Zealand Free Trade Area (AANZFTA). Nature and timing of proposed treaty action 7 The ANZCERTA entered into force between Australia and New Zealand on 1 January 1983. 8 New Zealand proposes that, subject to successful completion of the Parliamentary treaty examination process and passage of implementing legislation, Article 3 of ANZCERTA: Rules of Origin be formally amended through an Exchange of Letters ( the Amending Agreement ) between the Ministers of Trade of Australia and New Zealand. 9 The anticipated implementation date for Annex G is October 2010, although this is subject to alignment with the Australian regulation-making process. The implementation date for the Article 3 text will depend upon the Australian legislative process. It is expected that legislation will be passed in 2011. The ANZCERTA does not apply to Tokelau, the Cook Islands or Niue, therefore consultation on the Amending Agreement is not required. Reasons for New Zealand taking the treaty action 10 Under ANZCERTA s Article 3, the rules of origin are designed to protect the integrity of free trade between the countries by preventing exporters from third countries shipping their product through one party to benefit from preferential access to the market of the other. Rules of origin determine which products count as Australian or New Zealand products and thereby are eligible to enter the markets in either country at a zero tariff rate. 11 Major revision of the ANZCERTA rules of origin was undertaken in 2005/06 to allow a move from the traditional regional added value approach to rules of origin to a change in tariff classification approach. The new rules entered into force on 1 January 2007. 12 Review provisions were written into Article 3 of ANZCERTA to accommodate an early review of the new rules, particularly in those areas that retained an added value component. Section C (27) states The Member States shall complete a review within three 6

years of entry into force of this Article to address any differences between the Member States arising from the operation of this Article. 13 Since 2007 New Zealand and Australia have concluded separate bilateral free trade agreements as well as the plurilateral ASEAN - Australia - New Zealand Free Trade Agreement (AANZFTA). It is important that the CER ROO keep pace with these developments to ensure that trans-tasman exporters continue to enjoy the best access to each others markets and also to minimise the associated costs of having different rules applying to different markets. Key limitations of the current regime 14 The major limitation of the current regime is the imposition of supplementary regional value content requirements across most textile, apparel and carpet product lines. Regional value content requirements in any form (but especially those calculated on an exfactory cost method) impose significant compliance costs for exporters and administrative costs for agencies charged with enforcing such rules. 15 Under the current CER ROO many textile and apparel items must meet supplementary regional value content thresholds that range from 40 to 55%. In the case of men s and boys structured apparel the regional value content requirement is 50% based on the ex-factory cost method. The 50% regional value content threshold based on the exfactory cost method is too constraining for many New Zealand businesses operating in an open economy in a rapidly globalising world. The regional value content threshold constrains the degree to which firms can maximise the use of cost competitive inputs from the global supply chain. Also the ex-factory cost method only permits a narrow set of qualifying costs associated with local labour, overhead and material costs of the manufacturer. Profits, the costs of capital and transporting goods from the factory to the point of export and so forth are excluded from the manufacturer s local cost calculation, as are most costs associated with its out-sourcing to other local manufacturers. 16 The regional value content approach does not provide ongoing certainty for firms that exports will continue to gain preferential duty free access. Businesses operating on the margins of the regional value content threshold risk losing the tariff preference if there is movement in the exchange rate. Businesses on the margins also lose incentives to seek efficiency improvements in their production models, as these efficiency gains could see them fail to meet the regional value content threshold and lose access to the tariff preference. 17 Another limitation is the complexity of some of the change in tariff classification rules which can constrain manufacturing process options or add to business compliance costs. (For example some rules in the existing CER ROO are expressed as change of tariff heading xxxx except from headings yyyy to zzzz). In more recently concluded FTAs New Zealand has successfully negotiated simpler rules without these complex exceptions. 7

Advantages and disadvantages to New Zealand of the treaty actions Objectives 18 The review of CER ROO aims to ensure that the ROO facilitate and enhance trade in goods between New Zealand and Australia in line with the Single Economic Market objective of closer trans-tasman integration. 19 While the CER ROO implemented in 2007 were relatively liberal, there was room to enhance trans-tasman trade in goods through a more efficient trading environment. The review aimed to achieve this by removing undue barriers to preferential access such as supplementary the regional value content requirements, and by reducing compliance costs to business by extending the change in tariff classification approach across the vast majority of product lines. 20 Accordingly, the objective of the treaty amendments is both the enhancement of gains in preferential access for New Zealand exports to Australia and, in line with our SEM objectives, that we enhance trans-tasman integration. The review therefore required not only gains to New Zealand, but also to enhance trans-tasman market integration. Advantages 21 The proposed new rules bring the majority of textile, apparel and carpet product lines properly within the change in tariff classification regime and remove the supplementary regional value content requirements. 22 The advantages of the change in tariff classification approach: reduces compliance costs for businesses. Generally all the exporter needs to do is ensure that the imported inputs are classified differently from the goods being exported (as specified under the rules). Many will have customs brokers doing this for them and costs will depend on the complexity of the product; how many parts are imported etc. But unlike under the RVC approach there is no need for recording the value of each imported component, exchange rates at the time of importation, share of overheads per unit etc. This reduction in compliance costs is especially advantageous for small and medium enterprises; provides a much higher degree of certainty for exporters of preferential market access for business. The simple change in tariff classification approach removes uncertainties associated with price movements, such as exchange rate fluctuations, on the ability to qualify; allows manufacturers to plan ahead with confidence, allowing them to extract further production efficiencies and develop their business model in the face of global competition; removes the constraint on exploiting production efficiencies that may be created by regional value content requirements. It supports increasingly integrated cross border production models where manufacturing operations are split up amongst several countries; 8

is easier and cheaper to administer (the respective Customs administrations do not have to explore or verify complex accounting systems) thereby facilitating trade and trans Tasman integration; and is consistent with emerging international practice in Free Trade Agreements (FTAs) and with the approach under the New Zealand Thailand Closer Economic Partnership (NZTCEP), the Trans-Pacific Strategic Economic Partnership (Trans- Pacific SEP), the China New Zealand Free Trade Agreement, and the Asean- Australia-New Zealand Free Trade Agreement (AANZFTA). 23 While both economies will benefit from increases in trade, the removal of supplementary regional value content requirements will tend to better support competitive advantage for some New Zealand firms. This is because the relative differences in trans- Tasman labour costs means that it may be easier for Australian firms to meet an regional value content approach relative to New Zealand firms operating on the margin of the threshold. It should be noted however that many factors affect competitive advantage and the rules of origin may not be the main constraint in many instances. Disadvantages 24 The liberalisation of the CER ROO poses a risk that New Zealand industry will be adversely affected as a result of an increase in Australian products entering the New Zealand market duty free. 25 However, this risk to New Zealand industry is believed to be minor: There is no evidence suggesting that a large number of Australian firms are failing to qualify for duty free access as a result of constraining rules of origin. The supplementary regional value content requirements were removed from women s apparel in 2007; and in the three years to date there has been no evidence of a significant increase in imports of women s apparel from Australia. Arguably the imposition of supplementary regional value content requirements has been more advantageous to Australian exporters. Higher labour costs in Australia relative to New Zealand may have made it easier for Australian firms to meet the supplementary regional value content requirement. The supplementary regional value content requirements may therefore have acted as less of a constraint to Australian exporters in gaining preferential access. Other changes in the New Zealand s tariff regime will also lessen any adverse impact of increased duty free access for Australian imports. Unilateral tariff reductions over recent years now allow textiles to be imported into New Zealand at a 5% tariff rate without any need for compliance with a rule of origin. This 5% rate does not impose a significant barrier to the New Zealand market. However in terms of apparel there may be some advantage to New Zealand garment makers. The lower tariff for textiles provides New Zealand garment makers with a slight advantage in relation to their cost of imports over Australian garment makers who continue to face a 10% tariff on their imported textile inputs. 26 There will be a fiscal cost associated with the amendment. The liberalised rules mean that there is the potential for more Australian products to enter the New Zealand market 9

under preference of a zero tariff rate. This cost is expected to be minor and the foregone revenue is expected to be countered by the dynamic gains associated with the reduction in costs to New Zealand consumers and the removal of Australian tariffs faced by New Zealand exporters. A more complete analysis of the fiscal costs is contained in the Economic, Social, Cultural and Environmental Costs and Effects of the Amendment section of this NIA. Legal obligations which would be imposed on New Zealand by the amendment action, the position for reservations to the amendment, and an outline of any dispute settlement mechanisms Provision of information and verification 27 The specific obligations under Article 3 of ANZCERTA to provide that an importer may make a claim for preferential treatment based on a declaration by the exporter; to supply written determinations with reasons for any denial of preferential treatment; and to consult and exchange information in regard to goods claiming preference are currently already in operation in both Parties and are not affected by the proposed amendments. Rather the changes impact on the rules and methodologies for calculating any particular goods entitlement to preference. Consultation and modification 28 New Zealand and Australia have agreed to consult on the operation of this agreement as and when necessary. Reservations 29 As ANZCERTA is a bilateral treaty which has already entered into force there is no provision for reservations. Amendments can be made with the consent of both parties, subject to their necessary domestic procedures required to bring such amendments into force. Dispute settlement in ANZCERTA 30 There are no specific dispute resolution procedures under ANZCERTA. Measures which the Government could or should adopt to implement the treaty action, including specific reference to implementing legislation 31 Regulations by way of an Order in Council will need to be made under section 65 of the Customs and Excise Act 1996 to implement the Amending Agreement. There are no other options as to how to implement the Amending Agreement. The anticipated implementation date for Annex G is October 2010, although this is subject to alignment with the Australian regulation-making process. The implementation date for the Article 3 text will depend upon the Australian legislative process. Given that the upcoming Australian Federal election will reduce the number of parliamentary sitting days in 2010, it is most likely that legislation allowing implementation of the Article 3 text will be passed in 2011. Australian officials advise that it is extremely unlikely that implementation would take place after 2011. 10

Economic, social, cultural and environmental costs and effects of the amendment 32 Since the inception of ANZCERTA in 1983 both countries have moved progressively towards a deeper and broader integration of policies, laws and regulatory regimes through coordination, mutual recognition and harmonisation instruments. This has been strengthened by frequent communication and contact between Ministers and government agencies of both countries. The amendments to Article 3, which allow Australian and New Zealand businesses alike to purchase their inputs from the most internationally competitive source, complement Governments objectives to develop a trans-tasman single economic market (SEM). 33 The amendments to Article 3 of ANZCERTA fine-tune the CTC approach adopted in the 2005/06 review. Further liberalisation of the ANZCERTA ROO under a CTC approach will allow manufacturers to evolve their business practices in the light of international competition and will offer considerable dynamic benefits. They will support continued growth in New Zealand exports and our manufacturer s competitive position in our largest trading market. 34 The amendments to Article 3 of the ANZCERTA have no perceived adverse effects on Maori interests or inconsistencies with our human rights obligations. The costs to New Zealand of compliance with the amendment 35 Costs of implementing the amendments to Article 3 of the ANZCERTA (principally the removal of supplementary regional value content requirements across textile and apparel lines) will be negligible. Given the rules will be broadly similar to the AANZFTA and the China NZ FTA, implementation costs (preparing new training material and information material) are expected to be low. 36 Financial implications arising from this amendment are expected to be small. The changes to the product specific rules of origin are either: neutral because New Zealand s MFN tariff is zero (the rule of origin is irrelevant where the MFN rate is zero); neutral because although some rules may be phrased in a different way, they do not necessarily change the fundamental criteria for achieving preference; more liberal because the new rules lower the threshold to confer origin either by lowering or removing the added value threshold or by allowing more third party sourcing of inputs. 37 As the outcome of most consequence for this review resulted in more liberal access to preferential tariff rates between Australia and New Zealand, the main financial cost will be a potential loss of tariff duties paid to the New Zealand Government. 38 Due to the reasons outlined above, it is not anticipated that a larger number of products will now enter tariff free into New Zealand than previously. Trade between New Zealand and Australia under the headings where rules have been changed averaged around NZ$1.204 billion in exports to Australia annually over the three years 2006-2008. Imports from Australia were similar, averaging NZ$1.240 billion annually over the same three years. 11

The actual trade affected by the revised rules should be expected to be less than this however, as these figures include re-exports on which the revised rules will have no impact. 39 The area where the rules will have the greatest potential impact is in the textiles and apparel sector where regional value content thresholds are being lowered and in most cases removed. The majority of exports/imports between Australia and New Zealand will have been meeting the relevant thresholds anyway (the major benefit for these products is that a compliance step has been removed). For those operating on the margins of the regional value content threshold it will create certainty in the event of price movements such as those associated with exchange rate fluctuations or more competitive sourcing options. 40 Exports to Australia in these products over the period 2006-2008 averaged NZ$ 368 million annually and imports from Australia averaged $NZ 125 million annually. Figures supplied by Customs New Zealand show that the actual duty collected from these lines was NZ$ 936,367 in 2008, down from NZ$ 1,392,023 in 2007. This tariff revenue equates to less than 1% of the value of these imports, indicating that most of the imports are indeed entering duty free. This figure should be viewed as a ceiling of lost revenue to the government. 41 Revenue foregone by the New Zealand Government is expected to be at least neutralised by dynamic gains to the New Zealand economy associated with the liberalisation, such as the reduction in costs to consumers and to manufacturers who would benefit by: increasing access to duty free tariff rates into the Australian market for these products. (The window of opportunity and margin of preference - is reduced as Australia s tariff rates under their other FTAs move closer to zero (e.g. United States, Chile); being able to use these duty free products as inputs into their production; having more liberal access to global supply chains in order to source the most cost efficient inputs to aid their trade to Australia; and providing more scope for economies of scale in production, as these rules are now closely aligned with the origin requirements of other New Zealand agreements such as the ASEAN Australia New Zealand Free Trade Agreement. Completed or proposed consultation with the community and parties interested in the amendment 42 The following Government agencies have been consulted in the preparation of this paper and concur with its recommendations: the Ministry of Foreign Affairs and Trade, the New Zealand Customs Service, the Ministry of Agriculture and Forestry and the Treasury. 43 Revision proposals were published on MED s website and stakeholders were invited to make submissions. Further consultation with individual industry representatives was conducted on a case by case basis as required. While for some proposals in the textile and clothing sector there were mixed views, all submissions were generally supportive of further liberalisation of the CER ROO. 12

Subsequent protocols and/or amendments to the treaty and their likely effects 44 As mentioned above, the amended Article 3 has a specific consultation and modification section. The close and long-standing political relationship between Australia and New Zealand means that any issues of grievance or concern are addressed through discussion between the two Governments. As with this proposed amendment, any future amendments will be subject to the necessary domestic procedures, including Cabinet approval, before entry into force. Withdrawal or denunciation provision in the treaty 45 As this proposal is for an amendment to be made to an existing treaty, there is no withdrawal or denunciation provided for. The ANZCERTA itself can be terminated at any time by mutual agreement of the parties. 13