January 12, 2021
Brexit Reality Check: 7 Common Misunderstandings Under the New TCA
As the UK forges into its first weeks of independence from the European Union, the trade community is adjusting to new rules and regulations. As with most transitions, Brexit comes with some misunderstandings—which can have a costly impact on the supply chain if left unchecked.
Here, Flexport clears up common myths and highlights how new structures may apply, so businesses can take steps to minimize supply chain impacts.
Myth #1: A Brexit Deal Means Business As Usual
The EU-UK Trade and Cooperation Agreement (TCA) was announced on Christmas Eve, fueling a sense of relief that the UK had avoided the edge of an economic cliff. But the deal isn't just a redux of how the UK and EU operated before.
Reality: Even though a deal was reached, the TCA only deals with some aspects of trade between the EU and the UK.
Borderless trade and internal market mechanisms no longer exist as they did at the end of 2020. Nor does the TCA amount to a customs union, such as the one between Turkey and the EU, where goods can move tariff-free, provided duty was paid once.
Impact: Customs declarations are now required for every shipment—imports and exports. Physical inspections may delay freight. The additional processes apply to both sides of the border, just as they would at any other international border in the world.
Potential impact: Additional customs documentation is likely to create two additional outcomes: higher costs for doing business in the UK and congestion in ports.
For some small and medium businesses, the intricacies of tariff classification and valuation issues may have a chilling effect as companies opt out of opportunities across the new trade border.
Companies can overcome these obstacles in part via a combination of automation and expert partnerships. For instance, in Flexport’s platform, customers can assign EU and/or UK classifications to goods in commercial invoices, and the classifications follow SKUs across the product library. A customs broker can assist with classification accuracy.
Myth #2: EU-UK Trade Is Tariff-Free And Quota-Free
The idea that the Brexit deal guarantees 100% tariff-free and quota-free trade between the UK and the EU is an oversimplification. Where goods are manufactured makes a difference.
Reality: Products that are manufactured in the UK or EU are mostly subject to free trade between the two groups of countries. But, the goods do need to meet qualifying criteria.
Chinese, Japanese, or other third-country imports are still subject to full most-favored nation (MFN) tariff rates when traded between the EU and the UK.
MFN tariffs also apply to products that are produced with sizable component or raw material content from outside the UK or EU, even if final manufacture occurs in either place.
Potential impact: A large proportion of EU-UK trade is still subject to full tariffs and quota, which could increase prices for consumers and diminish profit margins for companies.
Businesses may look for solutions to avoid or offset these tariffs, by moving production facilities to avoid the need to import or export finished products.
Myth #3: UK or EU Final Manufacturing Circumvents Tariffs
Some companies are hoping that goods brought in from third countries are considered originating in the UK or EU if production is finalized in either place. If that were true, companies could avoid tariffs in certain circumstances. But, that’s not how it works.
Reality: A final manufacturing place doesn’t automatically grant originating status for tariff-free access. The TCA covers this in its Insufficient Production provision.
The provision provides a list of processing operations that help determine origination for tariff purposes. Packaging, labeling, filling, painting, polishing, and other finishing processes aren’t enough to avoid tariffs.
See the list in this draft version under Article ORIG.7: Insufficient Production.
Potential impact: Declaring preference status for goods which are the result of such minimal processing in either the UK or the EU could lead to a costly penalty.
As a result, many companies are reviewing the supply chain for insufficient production processes and adjusting supply sources or customs documentation as needed.
Myth #4: The Brexit Deal Replaces Other FTAs
Since the UK used to automatically be part of the EU’s free trade agreements, there may be confusion about which still apply now that the EU-UK TCA is in effect. Further adding to any misunderstanding, the UK has recently struck trade deals with more than 60 nations or groups of nations, which also took effect on January 1.
Reality: The Brexit deal only applies to trade between the EU and UK in goods these two groups of countries actually manufacture themselves.
As mentioned earlier in this blog, any goods traded between the two that were manufactured in another country will be subject to full tariffs—even if the EU and the UK have an FTA with that other country.
For instance, the UK and the EU each has its own FTA with Japan—the UK struck its deal during the Brexit transition period in October 2020—so products of Japanese manufacturing origin can be imported duty-free into the UK or the EU, provided they are shipped directly from Japan.
If those same Japanese goods are traded between the EU and the UK, they will not benefit from any of the three existing free trade agreements.
Impact: Businesses will need to deconsolidate orders from suppliers in the Far East, because they can no longer use a central distribution hub in Europe to supply customers in the UK and the EU. This means the distribution landscape in the UK is likely to change greatly, as more warehouse space becomes necessary. Additionally, once third-country products have been imported into either the EU or the UK, they can no longer be traded between the EU and the UK without having to pay duties.
Myth #5: Documentation for Zero-Tariff Status Is Easy
Rumors have cropped up that the documentary evidence required to obtain zero-tariff status is as simple as showing an export invoice (the so-called “supplier declaration”). Some go so far as to say the importer can just state their knowledge that the goods fulfill the deal’s requirements. If this sounds too good to be true, that’s because it is.
Reality: Neither the supplier declaration nor the importer’s self-recognition are automatic or easy. The Rules of Origin are technically complex and take up more than 70 densely packed pages of the agreement—in its draft version.
The TCA stipulates that whoever makes a zero-tariff declaration “shall be prepared to submit at any time . . . all appropriate documents proving that the information given on that declaration is correct.”
Failing to provide that proof, even in one instance, may result in retrospective duties and penalties for a 3-year period of trade. And, Customs authorities could potentially clawback all of the duty owed during the time period from the importer—resulting in damage claims or even legal action by the importer against the exporter.
Shippers must have near-absolute insight into and record-keeping of the bill of material specifications for any given product:
- Raw material suppliers
- Tariff classification of each and every component
- A commercial record of the manufacturing overhead costs
- A commercial record of profit margins on a case-by-case basis
Potential impact: The cost of performing, maintaining, and archiving this proof of origin may be higher than the actual financial savings of zero-tariff trade. On most commodities, both the UK and EU already have no or low tariffs, ranging from 0.5 to a few percent.
Myth #6: Northern Ireland Can Take Part in Free Trade Like Before
Confusion around the status of Northern Ireland may stem from a misbelief that Ireland, Northern Ireland, and the Republic of Ireland all mean the same thing. On top of that, Northern Ireland is actually treated differently than the rest of the UK under the TCA.
Reality: In short, Northern Ireland retains some benefits of internal market trade with the EU, but has formally left with the UK. The Republic of Ireland is a full EU member state and trades under EU FTAs as before.
A brief geography lesson helps to clarify: The UK’s full name is The United Kingdom of Great Britain and Northern Ireland.
Great Britain is England, Scotland, and Wales, while Northern Ireland—which comprises six counties at the northern point of the geographical island of Ireland—became a discrete country as part of a 1998 agreement.
So, Northern Ireland has left the EU, because it is part of the UK, but its political past means it’s treated differently.
A history lesson to go with the geography: When Northern Ireland became part of the UK, both governments agreed the border between the north and the Republic of Ireland should remain almost invisible—no cameras, no border posts.
When the UK, and, thus, Northern Ireland was part of the EU, this was easy. People and goods could move across the border unhindered.
Now, a compromise consisting of a hybrid solution allows Northern Ireland to keep an overall soft border with the Republic of Ireland, compared with the borders between Great Britain and the EU. A new regulatory border now exists in the Irish Sea between Northern Ireland and Great Britain (England, Scotland, and Wales).
Impact: Since Northern Ireland follows many of the EU's rules on trade, trucks can drive across the border without inspection. Some EU legislation, like the Union Customs Code and sanitary and phyto-sanitary (“SPS”) controls, will still apply.
Potential impact: Shipping delays are likely between Northern Ireland and Great Britain and the Republic of Ireland and Great Britain.
Direct ferry services are beginning to crop up between France and the Republic of Ireland, because both are EU member states. Ferries will replace trucking routes that otherwise have to cross the congestion and customs checks of Great Britain.
Myth #7: Supplier Discounts Don’t Impact Originating Status
Discounts can incentivize decision making, but companies should watch for a slippery slope of shifting values.
Reality: When discounts change the percentage of non-originating raw material content in the final product, originating status can change, too.
For certain product categories, the TCA allows non-originating materials content of up to 50% of the EXW value of the final product. The key point here is the proportion of the value of the materials used matters, not the proportion of just the materials used.
A Bill of Materials (BOM) breaks down the EXW value, by percentage proportions, of every raw material used in the manufacturing process, as well as other contributing factors to the COGS (cost of goods sold), such as manufacturing overhead and profit margin.
If a UK exporter of a finished product gave an EU buyer a discount (or vice versa), the percentage of non-originating content could change, and the product could potentially lose its preferential status under the TCA.
As a simplified example, if a UK exporter sells a product containing $49 of non-originating raw materials to an EU buyer for US$100, the product will satisfy the 50%-rule ($49 out of $100 is less than 50%) and duty-free access is justified. Should the UK exporter suddenly sell the same product for a discounted US$80, the non-originating content suddenly becomes greater than 50% (49/80 = 61.25%) and the product will be subject to duty at the regular third-country MFN rate.
Potential impact: Miscalculations on non-originating values due to a discount can result in underpayment of duties.
Even when by mistake, underpayment can be messy to fix, including post-entry amendments, audits, or loss of import or export privileges. Some companies may choose to pursue damages with suppliers if the supplier submitted a wrongful declaration.
Please note that the information in our publications is compiled from a variety of sources based on the information we have to date. This information is provided to our community for informational purposes only, and we do not accept any liability or responsibility for reliance on the information contained herein.