October, 2018

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NAFTA Drawback: A Flawed Policy Initiative

Mark K. Neville, Jr.

It is well known that discussions have been underway among the three NAFTA participants for many months. Many of the issues are contentious and some would argue that some, at least, of the US negotiation objectives are ill-advised. An example of the latter is the notion that dispute resolution under NAFTA Chapters Eleven and Nineteen1 should be watered down or scrapped altogether.

But there are some features of the NAFTA that are really flawed and in need of a thorough revision. In the context of NAFTA, duty drawback, and other duty deferral trade planning programs such as use of a foreign trade zone (FTZ) or a Temporary Importation Bond (TIB)2 under Chapter 98 of the Harmonized Tariff Schedule of the United States (HTSUS), all but scream out for a major overhaul.

If a company imports a product and then uses it in manufacturing, or further processes it, before re-exporting the finished product, should the importer be able to take advantage of duty drawback or make use of an FTZ or TIB? After all, these programs are built for the express purpose of promoting US-based value-added activities and exports from the US.

In the absence of NAFTA, the immediate response would be an emphatic “yes, it is possible to eliminate the duty on the imported article by use of duty drawback, or such duty deferral programs as use of a foreign trade zone (FTZ) or a Temporary Import Bond (TIB) process.” NAFTA complicates things.

In the ordinary course, the exporter would look to either an unused3 or a manufacturing4 drawback claim, showing that the duty had been paid on the imported material and that the finished product was later exported to Canada. With NAFTA, there was an ill-advised limitation built into drawback and the earlier “same condition” standard was preserved. One presumes that the US negotiators wanted to ensure that Mexican and Canadian companies would not be able to effectively escape the payment of duty on the import of parts or raw materials into their countries and then escape the payment of duty into the US because the product imported into the US qualified for NAFTA benefits. Then, too, the intention may have been to force the use of US-origin parts and raw materials. But what they wound up doing was hamstringing US manufacturers.

Good Subject to NAFTA drawback

The rule is set forth in the statute. Under Section 3333(a), 19 USC § 3333 (a), a “good subject to NAFTA drawback,” i.e., subject to the limitation, means any good other than, inter alia—

(2) A good exported to a NAFTA country in the same condition as when imported into the United States.
For purposes of this paragraph—

(A) processes such as testing, cleaning, repacking, or inspecting a good, or preserving it in its same condition, shall not be considered to change the condition of the good. 5 Emphasis added

Thus, the general rule is that imported goods are subject to the Nafta drawback rule. The legal consequences of a good found subject to NAFTA drawback is found at 19 USC § 1313 (n) (2), 19 CFR § 181.44.. For the NAFTA drawback products the application of that rule effectively means that the exporter must enter the imported product with US customs again, and the duty to be collected on the product to be reexported is the “lesser” of the two duty rates in effect. To illustrate, if the finished product is dutiable at 0% in Canada but the imported good was dutiable at 5% in the US, the US credits the duty to be paid in Canada (0%) against the applicable previously paid US duty (5%), leaving the exporter with no refund and the previously paid 5% duty paid intact.

In contrast, goods exported “in the same condition” are entitled to full drawback—a refund of 99% of the full 5% duty that was previously paid.6 It is important to recognize that “same condition” standard is considerably narrower than that for “unused” merchandise,7 the latter allowing various processing steps that are “incidental operations”8 but only disallowing a use of the imported merchandise for its intended purpose.

“Same Condition” Defined

It is important to recognize that the drawback rule was changed in 1993 under the Mod Act, which ushered in the new concept of “unused goods” for 19 USC § 1313 (j) vs. the older, “same condition” standard. Perhaps another way of looking at the subject is that NAFTA drawback goods remain under the older standard. Further, only “direct identification” drawback is allowed on exports to NAFTA countries.9

The statute sets forth (at 19 USC § 3333 (a) (2) (A)) a limited listing of permitted processing steps that allow imported goods to retain their “same condition” status:

processes such as testing, cleaning, repacking, or inspecting a good, or preserving it in its same condition

The regulations expand this listing, however, as the pertinent NAFTA regulation is at 19 CFR § 181.45 (b) (1):

Same condition defined. For purposes of this subpart, a reference to a good in the “same condition” includes a good that has been subjected to any of the following operations provided that no such operation materially alters the characteristics of the good:

(i) Mere dilution with water or another substance;

(ii) Cleaning, including removal of rust, grease, paint or other coatings;

(ii) Application of preservative, including lubricants, protective encapsulation or preservation paint;

(iv) Trimming, filing, slitting or cutting;

(v) Putting up in measured doses, or packing, repacking, packaging or repacking; or

(vi) Testing, marking, labeling, sorting, or grading. Emphasis added.

The emphasized qualification should not be overlooked.

To be sure, the NAFTA also contains a further built-in exception for imported originating goods. This means that an article imported into the US from Mexico or Canada that meets the “originating goods” status of the NAFTA may enjoy full drawback or duty deferral benefits. Art. 303.6 (e) sets forth the exception

6. This Article [limiting drawback and duty deferral] does not apply to:

(e) an originating good that is imported into the territory of a Party and is subsequently exported to the territory of another Party, or used as a material in the production of another good that is subsequently exported to the territory of another Party, or is substituted by an identical or similar good used as a material in the production of another good that is subsequently exported to the territory of another Party.10

In essence, in the absence of this exception, unless the product was re-exported to a NAFTA partner country “in the same condition,” meaning that it has not undergone any but the just cited “processing steps” or “operations” and is directly identified,11 the exporter must deal with the “lesser of” rule.


The same limiting rule applies to FTZs—the imported good that is manufactured or otherwise changed in condition in an FTZ is effectively denied the opportunity to avoid the payment of US duty, which opportunity would otherwise apply when the goods are directly withdrawn from the FTZ for direct export to a foreign country.. 19 CFR § 181.53 (b) (4).


With TIBs, we see a nuanced and limiting drafting effort. The TIB program typically allows, with the posting of a bond, the duty-free entry of imported merchandise for alteration, repair or processing. 19 USC § 9813.00.0500, HTSUS. Importantly, the general rule allows processing in the nature of further manufacturing of the imported article (“including processes which result in articles manufactured or produced in the United States”). This broad range of permissible activities has been pulled from TIB in the NAFTA context. The NAFTA regulations allow only alteration or repair—no processing.12

The term “alteration” has been narrowly construed by CBP in the context of TIB/NAFTA as a process leaving the product intact and is short of what might be considered as manufacturing:

An alteration is a change to a finished product that does not amount to an additional or vital step in its manufacturing.13

It may be interesting to examine a few scenarios in connection with this discussion.

Nitriding of imported steel pipe

In a 2017 CBP was asked to decide whether a processing undertaken on imported steel pipes, nitriding, was a permissible alteration.14 There, CBP determined that

On a physical basis, while the identity of the pipe was not changed and was still “pipe”, the properties of the pipe changed after applying the nitride process.
*   *   *   
Here, the nitride process, similar to the pressing operation that was before the Dillingham court, made the steel pipes suitable for their intended use in drilling operations…[H]ere the nitride process increased the durability of the steel pipes to reduce the effects of scratching, deformities, chemical breakdown and corrosion over time. Here, the application of a nitride process provided the steel pipes with new chemical and physical properties. Therefore, the application of a nitride process to the steel pipes conferred an advantage that exceeded the meaning of an alteration…
*   *   *   
[B]ecause the application of nitride to the steel pipes constituted an additional and vital step in the manufacturing process, and the pipes were exported to Canada, the imported pipes did not qualify for exemption from the lesser of duty rule
*   *   *   


In an earlier ruling, CBP held that an imported powder that was subjected to sifting, repacking and labeling was entitled to an exemption from the NAFTA rules:

The above-described sifting, repackaging, and labeling qualifies the imported 10SH-PF powder for duty-free treatment under a TIB under subheading 9813.00.05, HTSUS. In addition, imported 10SH-PF powder and exported 10SH-PF powder that has undergone only sifting, repackaging, and labeling as described in this ruling request is in the same condition for purposes of 19 U.S.C. § 3333(a)(2) and 19 C.F.R. § 181.45(b). Therefore, the 10SH-PF powder is not a “good subject to NAFTA drawback.”15

Carbon Steel

In the case of imported carbon steel the exemption from the NAFTA rules did not apply because it had been bent to shape, and this was not one of the steps enumerated in the statute or the regulations that could be undertaken while safely preserving “same condition” status. Ruling no. H270737 (3/1/17).

Encapsulating of ferroalloy powder

Imported allow powder is placed into or “encapsulated in” steel tubing and the resulting product is called a “cored wire.” Importantly, the bulk alloy powder and the cored wire may be classified in the same tariff provision. In the case of ferroniobium, for example, duty is paid at the rate of 5% ad valorem pursuant to tariff item no. 7202.93.4000, HTSUS, which is the same tariff provision for cored wire.16

CBP has determined that the steel tubing that encapsulates the powder is mere packaging—is borne out in earlier tariff classification rulings. In ruling no. 964553 (5/2/01), the subordinate role of the steel tubing as packaging for alloy powder was expressly recognized by CBP:

The merchandise at issue consists of hollow non-alloy steel tubes, typically 15 to 16 inches in outside diameter, cored with an alloyed powder containing calcium, silicon and iron, along with minor amounts of other elements. These cored wires are used in steel-making as a means of introducing the alloys to the melt in order to impart the requisite properties to the steel. The wire is fed into the melt at a particular rate so that the amount and distribution of the powders in the molten steel can be controlled. The metal tube functions only as a container for the alloyed powders and does not enhance the product. Emphasis added.

More importantly, CBP has been requested by an importer to view the forming of the cored wire containing imported ferro-titanium powder as a further processing such as is contemplated by a temporary import program that allows the duty-free entry of articles of metal if they are to undergo further processing.17 In ruling no. 563401 (6/22/06) the description of the forming of the tubing, the placing of the powder in the steel tubing and the subsequent use of the cored wire in the steel industry are discussed in detail. The ruling noted the following;

In this case, the titanium from the United States is melted, formed into titanium ingots, and then crushed to form ferro-titanium powder in the United Kingdom. It is our opinion that at this point the ferro-titanium powder is a commercially finished article for purposes of subheading 9802.00.60, HTSUS. In this regard, we believe the evidence in this case shows that jacketing the ferro-titanium powder facilitates the process of introducing the powder into molten steel by tightly encasing the powder but that jacketing does not otherwise impart new properties upon the ferro-titanium powder itself.

It is clear that CBP saw the placing of the powder into the steel tube as an “encasing.” Further, CBP perceived the fact that the powder’s properties had not changed signified that the powder had not been further processed for purposes of this partial duty exemption. That is not directly on point for a case arising under the NAFTA drawback rules, but the question whether there has been a “processing” is certainly common to both a NAFTA drawback and a 9802.00.6000 inquiry alike.

We might also make the point that the placement of the powder into the steel tubing permits a regulated introduction of the alloy, in measured amounts. Thus, this echoes the regulation’s approval of putting up of imported products into “measured doses” within the “same condition” rubric.
We should be able to follow the train of CBP’s logic in these cored wire rulings that:
  1. The alloy powder only undergoes packaging, which is a permissible operation for “same condition” purposes, by being placed in the tube. Ruling no. 964553.
  2. The forming of the cored wire containing the imported alloy powder has been affirmatively held not to be a “processing” going beyond packaging. Ruling no. 563401.
  3. In the absence of a disqualifying processing, it follows that the limits of the “same condition” standard would not be breached.

Sodium Selenite

In a 2009 ruling,18 CBP assessed the customs status of imported selenium, which is used as an ingredient in animal feeds in its concentrated form. Because some customers prefer a diluted form of the product, the importer arranged to dilute the concentrated selenium into selenium premix. The premix was sold in concentrations of 1%, 3%, 4% or 4.5% selenium, and the importer contended that it is commercially interchangeable with the high concentration form.

Selenium premix is the result of adding either “rice hull middlings” (“rice hulls”) and/or calcium carbonate (“calcium”) or limestone to the selenium. Rice hulls are the outermost covering of rice and are a by-product of human food processing. Rice hulls and calcium carbonate are each “filler ingredients.” These substances are combined in a 1-ton mixer, along with the necessary amount of selenium to achieve the desired dilution. The importer stated that the substances that dilute the selenium concentration are inert and non-functional.

The dilution is a weakened concentration of the selenium for those who may prefer using specific concentrations of the ingredient. CBP held that this dilution was a permissible operation within the confines of a “same condition” analysis.

As a result, the mixing in the US after importation of the imported concentrated selenium with limestone, rice middlings or calcium carbonate and the later exportation back to Canada of the mixed product, i.e., the selenium premix, is not subject to NAFTA drawback because it is exported in the same condition as imported.


Based upon our analysis of the relevant statutory program, we must conclude that
  1. The NAFTA is being renegotiated and this limitation on drawback, FTZs and TIB benefits may be removed in future in a revised NAFTA. If NAFTA were to be terminated, there would be a reversion to the normal drawback rules for manufacturing or unchanged condition.
  2. Unless and until (i) NAFTA is renegotiated and a change to the rules were accepted or (ii) NAFTA is terminated, the present NAFTA limitation on drawback, FTZs and TIB will remain in place.
  3. If “same condition” status is ensured, because the “same condition” principle applies in all three programs (drawback, FTZ and TIB), it makes the most sense to consider that program that confers the biggest benefit. That could be duty drawback, as the importer will want to be able to recover for past exports. It would, of course, be possible to look at drawback for past entries and to TIB or FTZ use for future entries.


For a discussion of investor/state dispute resolution under Art. Eleven of NAFTA, see Neville, “NAFTA Investor Arbitrations,” 24 JOIT Mar. 2014 at 23.

2. See discussion, Neville, “Temporary importations under bond, or “Don’t assess duty, that article is not staying here,” 19 JOIT Mar. 2009 at 21.

3. 19 USC § 1313 (j).

4. 19 USC § 1313 (a).

5. 19 USC § 3333(a)(2).

6. Sections 181.41-.45 of the Customs Regulations.

7. A definition of the term “unused merchandise” was not provided in the language of the act. However, in ruling no. 225552 (11/1/94), CBP discussed Customs Service Decision (“C.S.D.”) 81-222, dated May 27, 1981 and C.S.D. 82-135, dated June 4, 1982, which found that an article is used when it is employed for the purpose for which it was manufactured or intended. See ruling no. H255109 (10/21/15) and authorities cited therein, ruling no. H258306 (5/28/15) (use of imported item as a demonstration model to solicit orders is a disqualifying “use”). An article is also “used” when it is used in the manufacture or production of another article. See C.S.D. 82-67 (12/22/81).

8. Exemplars are provided at 19 USC § 1313 (j) (3). See discussion at ruling no. H018068 (10/29/09).

9. Substitution same condition drawback, normally available under Section 1313 (j) (2) was eliminated for exports to NAFTA partner countries by 19 USC § 1313 (j) (4) (A). This program expands drawback eligibility to exported goods that share tariff classification (previously commercially interchangeable and, even earlier, fungible with) with the imported goods rather than only the previously imported goods themselves. The net effect of this limitation is to severely restrict NAFTA drawback to "same condition, direct identification" vs. the more liberalized "unused, substitution" standards that govern most other drawback claims.

10. Codified at 19 USC § 3333 (a) (5).

11. On this latter point, as we have seen, substitution same condition drawback is beyond reach on exports to NAFTA partner countries.

12. 19 CFR § 181.53(b)(5).

13. E. Dillingham, Inc. v. United States, 29 Cust. Ct. 16 (1952).

14. Ruling no. H264562 (4/3/17).

15. Ruling no. H255100 (6/22/15).

16. See, e.g., ruling nos. 088637 and 089143 (4/26/91).

17. This issue of “further processing” arose because subheading 9802.00.6000, HTSUS, provides a partial duty exemption for certain metal articles that are manufactured or subjected to a process of manufacture in the United States, exported for further processing, and returned for further processing in the United States.

18. Ruling no. H048148 (5/5/09). Cf. ruling no. W231152 (6/13/06) (adding propylene glycol to imported liquid fungicide to improve “flowability” changes the condition of the liquid fungicide to the extent that it has become “used” because flowability is a characteristic not found in the liquid fungicide before that addition).

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