USMCA Goes into Effect and Replaces NAFTA

The U.S.-Mexico-Canada Agreement (USMCA) became effective July 1, 2020, implementing the renegotiation of the North American Free Trade Agreement (NAFTA). The agreement has been a central focus of the Trump administration’s trade policy since negotiations with Mexico and Canada to revise NAFTA began in 2017.

The new agreement includes 34 chapters as well as side letters and annexes that address an array of issues, including rules of origin for automobiles and chapters on digital trade, intellectual property, labor, and the environment. Following are some of the key developments.

Automobiles: The USMCA includes stricter rules of origin for trade in automobiles. The agreement increases the regional value content—the share of a product’s content that must originate in the region—to 75 percent, up from 62.5 percent under NAFTA. Additionally, the agreement includes a Labor Value Content (LVC) under which 30 percent of an automobile’s production must be done in factories where the average wage is at least $16 per hour. In 2023, this requirement rises to 40 percent for autos and 45 percent for light trucks. Also, 70 percent of the steel and aluminum used in vehicles must originate in the United States, Canada, or Mexico.

Dairy: The USMCA provides U.S. agricultural producers with increased access to Canada’s dairy and poultry markets. Canada retains its dairy supply management system of production limits, price setting, and import restrictions but expands certain quotes and eliminates certain price classifications for powdered milk products.

Digital Trade: The agreement includes a new chapter on digital trade, an issue that NAFTA, which was implemented in 1994, did not address. The chapter includes a prohibition on tariffs on electronically distributed digital products. It also addresses cross-border data transfer, limits “data localization” requirements on where data can be stored, and limits the ability of parties to require the disclosure of proprietary computer source code and algorithms.

Energy: The USMCA adds a new chapter that codifies Mexico’s 2013 constitutional reform for the energy sector and recognizes the Mexican government’s direct ownership of hydrocarbons.

Intellectual Property: The USMCA’s chapter on intellectual property retains NAFTA’s copyright and patent protections and implements several changes. These include protections against the circumvention of technological protection measures, criminal and civil penalties for trade secret theft, and protection for pharmaceutical and agricultural companies.

Labor: The labor chapter includes a requirement that the parties adopt and maintain labor rights as recognized by the International Labor Organization. The chapter also includes provisions to prohibit the importation of goods produced by forced labor, address violence against workers exercising labor rights, and ensure the protection of migrant workers. An annex to the labor chapter requires Mexico to pass legislation that recognizes the right to collective bargaining.

Environment: The USMCA’s environment chapter requires the parties to implement obligations under certain multilateral environmental agreements. It also includes protections for certain marine species as well as provisions on air quality, sustainable forest management, and procedures for environmental impact assessments.

Financial Services: The financial services chapter includes commitments to allow for increased market access for U.S. financial institutions. The chapter also strengthens existing provisions on cross-border data transfer as well as a prohibition on data localization. A separate annex on cross-border trade includes electronic payment services in its market access provisions.

Sunset Provision: The USMCA includes a sunset provision, which requires the three signatory countries to review the agreement after six years. The agreement can then continue for 16 years after which the parties can renew the agreement for another 16 years.

Other Provisions

The USMCA also includes new provisions that address a range of issues, including:

• Obligations to prevent currency manipulation;
• An increase in the de-minimis customs threshold for duty-free trade;
• A requirement that any USMCA party that wants to negotiate a free trade agreement with a non-market economy must notify the others of its intention.

Tax Treaty Effect

To address uncertainty over the effect of the new agreement on U.S. income tax treaties, the IRS will interpret references to NAFTA in U.S. income tax treaties as references to the USMCA. The IRS noted that most U.S. bilateral income tax treaties contain limitation on benefits (LOB) articles, which include provisions and tests to prevent residents of a treaty jurisdiction from inappropriately accessing tax treaty benefits. The Treasury and the IRS will also reach out to treaty partners to confirm that they agree with this interpretation.

© 2020