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Facilitated Customs Arrangement: Does it work and at what price?

FCA: Does it work and at what price?

On July 12, 2018 UK Prime Minister Theresa May has published the long awaited Brexit White Paper. It is a comprehensive and ambitious plan which aims on the one hand to preserve a frictionless trade between the UK and EU and to resolve the Irish border issue, but also to achieve a UK independent trade policy, where the UK is able to conclude its own free trade agreements with third countries such as the USA.

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Facilitated Customs Arrangement: Does it work and at what price?

A key corner stone of the UK's proposal is the establishment by the UK and the EU of a free trade area for goods and maintain a common rulebook for goods, including agri-food. It further provides for a phased introduction of a new so-called Facilitated Customs Arrangement (FCA) that would remove the need for customs checks and controls between the UK and the EU as if they were a combined customs territory.

It is the FCA that will create very serious problems and may undermine the wish of the UK to conclude its own free trade agreements with third countries such as the USA. 

What is the FCA and what does it do?

The FCA tries to mirror the EU's customs approach at its external border. The idea is that goods entering the EU via the UK have complied with EU customs processes and the applicable EU tariffs have been paid. This would be done by the UK customs authorities (which would be the same as currently with UK being an EU member). The thought is, that this would remove the need for customs processes between the UK and the EU, including customs declarations, routine requirements for rules of origin, and entry and exit summary declarations. This means that where a good reaches the UK border, and the destination is clear, the UK tariff will apply if it is destined for the UK and the EU tariff will apply if it is destined for the EU. In case the destination is not clear at the point of import, the higher of the UK or EU tariff will apply. Where the good's destination is later identified to be a lower tariff jurisdiction, it would be eligible for a repayment from the UK Government equal to the difference between the two tariffs.

This proposal triggers various questions.

  • A third country has an FTA with the EU but not with the UK
    If the EU has established an FTA with a country where the UK has no trade deal and these goods have been imported in the EU, how long do these goods need to stay in the EU to be moved freely and without duties to the UK? A week, a year, a decade? Who will keep track of this? Will that be a government or a business responsibility? We fear the latter. What if this same product is imported and processed in the UK and further down the chain shipped to the EU? Who keeps track of this? We fear business again. In the latest example, it would be in the benefit of business (to obtain the lower tariff) but in the reverse case where the material has been imported into the EU first with zero duty, processed and then shipped to the UK, duties would have to be paid in the UK. Who will be the customs debtor? Probably the person who brings the goods to the UK? If he is further in the chain, how does he know that duties are underpaid?

  • The UK has an FTA but the EU does not have an FTA with a third country
    The situation become even more complex when semi finished products from the EU are exported to the UK and subsequently sold to the US where we assume that the UK has reached an FTA with the USA and the EU doesn't. Obviously, the USA would like to ensure that the UK products – which would benefit from a zero tariff under the US-UK FTA – originate from the UK and that it doesn't open a back door for EU goods. This requires that the UK exporter may only take into account EU components until the threshold of the specific origin rule is reached. Especially for manufactured products such as in the automotive industry it will become extremely difficult to meet the rules of origin requirements, because a substantial part of the components are sourced outside the UK. UK trade is so much integrated with EU trade that many components will not meet the narrow UK origin requirement.

Diagonal cumulation required

To ensure the trade in goods between the UK and the EU remains frictionless at the border, the UK proposes arrangements that facilitate cumulation with current and future FTA partners with a view to preserving existing global supply chains. This would allow EU content to count as local UK content in UK exports to its FTA partners for rules of origin purposes, and UK content to count as EU local content in EU exports to its FTA partners. Diagonal cumulation would allow UK, EU and FTA partner content to be considered interchangeable in trilateral trade. And this is where the problem is. Practically no FTA foresees in diagonal cumulation. So this needs to be negotiated and will most likely absorb a lot of time. It is therefore unlikely that if diagonal cumulation will apply for some or all existing FTA's that this will be realized before the end of the transition phase. As a consequence many products that currently meet the rules of origin will after Brexit no longer qualify. The negative consequences will be bigger for UK manufacturers as for EU manufacturers, because for EU manufacturers all EU components qualify and for UK manufacturers only UK components qualify.

The result will be that without diagonal cumulation the benefit of an independent FTA realized by the UK will primarily be for wholly obtained products, such as meat, vegetables etc. and not so much for manufactured or processed goods.

Conclusion

Having said this, the conclusion from all of this is, that the UK can only agree FTA's with third countries which have an FTA with the EU as well. One important Brexit deliverable for the UK is for the UK to conclude its own FTA's. That objective cannot be reached since the UK's bottom line choice will effectively be limited to those countries which have an FTA with the EU already. That is the same result as under the alternative of the UK entering into a customs union agreement with the EU. And this is an option that the UK has always refused. If that is the bottom line conclusion, why not try to negotiate a single market of goods with the EU – also known as the Jersey model?  This seems a better solution for the UK, the EU and businesses. The EU will probably consider this cherry picking and one can expect that only an appropriate annual financial contribution into the EU budget can make this acceptable to the EU.


Robert van der Jagt and Leon Kanters
Tax partners with KPMG Meijburg and members of KPMG's Dutch Brexit team.

 

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