Trade has overtaken tax reform as the hot topic in the auto industry, according to Steven Davis from KPMG’s Value Chain Management practice. He, and Doug Zuvich from KPMG Trade and Customs, led Steve Gardon, Vice President, Global Indirect Taxes & Customs at Lear Corporation, and Everson Ascencio, General Director – Global Customs at General Motors, in a discussion on the details of the latest tariffs and trade deals affecting the sector.
“Some in the U.S. see liberal free trade policies as negatively impacting the U.S. economy,” Davis said. As a result, large multinational trade deals like the North American Free Trade Agreement (NAFTA) have been reconsidered.
Ultimately, trade wars and tariffs are just tools in the fight between the two largest economies in the world, he added. China is turning its attention from excelling as the low-cost, high-volume manufacturer into a tech leader, and the U.S. has had to increase its focus on protecting its intellectual property.
“There's a tariff discussion going on, but this is really about who is going to be the next powerhouse in technology, and a fight over 5G.”
“Trade is now a policy lever,” Zuvich agreed, providing an overview of U.S. tariffs, including sections 201, 301, and 232, as well as global retaliatory tariffs and negotiations around exemptions. Global trade tensions are expected to remain elevated, and steel and aluminum tariffs will likely stay in place through 2019 as a means to get countries to the negotiation table.
Indeed, the U.S. administration remains inclined to levy steep tariffs on imported autos and auto parts as a threat to force Japan and the European Union to negotiate, Zuvich added. However, as of the Detroit Auto Show, these tariffs were not likely to move forward in 2019 because of staunch opposition from the U.S. automotive industry and a lack of support among Republicans.
“Even if there's a change in administrations, it's entirely logical to say that the policies—at least with respect to China—would remain as is,” Gardon added. “They're going to evolve, but I think the protectionist stance is going to remain.”
Once OEMs and suppliers assess the true economic impact of tariffs on their organizations, they can try multiple routes to try and reduce the impact, Davis said. These include pure trade strategies, changes to supply chain operations and/or potentially passing costs on to suppliers, vendors or even customers. How far companies may be willing to go of course depends on how material the impact is and how long it’s expected to last.
Other upstream considerations include understanding the countries of origin for materials import, how materials are classified, whether suppliers can be switched, and the global manufacturing, logistics and distribution footprint.
Changes can also be made downstream, but not without possible commercial impact, Davis said. “If you increase your price, it's likely to have an impact on market share; and it may have an impact on brand.” Changes to operations and transactional flows also can introduce new tax liabilities. “You don't want to solve your tariff issues and create tax issues.”
The impact of the 232 steel and aluminum tariffs varies significantly by company depending on their mix of products, inputs, and materials sourcing, Gardon said. And because domestic steel prices also have risen to the level of foreign tariffed steel, companies that source only from the U.S. are still impacted greatly.
Meanwhile, 40,000 exemption applications have been submitted, but the process requiring detail on a product-by-product basis is “torturous,” he added. It’s unpredictable, political, and the domestic industry has an opportunity to argue against the petitioner. On the positive side, the tariffs related to Mexico and Canada are a short-term issue likely to be resolved by the United States-Mexico-Canada Agreement (USMCA).
Alternatively, 301 tariffs related to China represent a long-term issue, necessitating new sourcing options requiring certification of supplier locations, Gardon said. “People are coming around to the view that this isn't going away, and the model of sourcing from China for use and production in North America…is going to remain less attractive.”
In general, USMCA modernized what had been NAFTA, but the benefits to individual manufacturers vary, Zuvich said. “If you're a U.S. OEM, U.S. supplier, you’ve got more complexity, but you're probably in a better position than another company that has to import engines or other significant parts of their vehicles.”
The regional value content (RVC) requirement for OEMs is rising to 75 percent from 62.5, making it harder to qualify for duty-free treatment. The tracing list to track the value of certain parts was eliminated, complicating matters. Certain core parts must originate in North America at 75 percent; 70 percent of the steel and aluminum purchased by the producer has to be North American; and 40 or 45 percent of the labor value content (LVC) has to earn $16 dollars an hour or higher, excluding benefits.
For suppliers, three tiers determine how much has to be regionally sourced, from 75 percent for core items like the engine and car bodies, to 70 percent for tires and other principal auto parts, and 65 percent for complementary parts such as wire harnesses, as examples, Zuvich said. “Determining the impact is not easy because not everyone has visibility into where all the suppliers are getting their parts.”
The OEM’s impact and process is very similar to the supplier, Ascencio said. Although OEMs aren’t obligated to comply with LVC, RVC requirements will make the qualification of passenger vehicles and light trucks more difficult because it requires more averaging across the board. “The amount of requirements and the complexity to getting there is going to be huge, [requiring] a significant amount of administrative technology to support us."
Steel and aluminum requirements should not pose any issue to U.S. OEMs because they largely source from North America, Ascencio said, adding that GM, for example, manufactures core parts like engines and transmissions locally.
“We don't see the cars being manufactured here in U.S. being really affected on this requirement. It looks like it was more of a link for 232, and to push a little bit for the USMCA to have this kind of requirement,” he said. However, for Japanese and European OEMs that import a significant number of transmissions and engines, qualification will be an issue. “They need to invest more in auto parts or localize more here for sure.” Ascencio said he thinks some companies will relocate their supply chain or manufacturing plants so that U.S. companies would supply U.S. OEMs, Mexico to Mexico, etc.
But because most OEMs already largely self-produce core content such as engines and transmissions in the U.S., qualification for those parts should be even easier under USMCA than it was under NAFTA.
Finally, U.S. and Canada production should meet the LVC requirement, he said, but Mexico production may prove to be more of a challenge.
The USMCA side letters exempt vehicles from Canada and Mexico into the U.S. from section 232 tariffs, Zuvich added. “Companies feel pretty comfortable right now that that's not going to impact those vehicles, so they can keep their manufacturing in Canada and Mexico.”
From the supplier’s perspective, the USMCA is clearly stricter, regardless of category, and requires more North American content to qualify, Gardon said. As such, OEMs and suppliers will have to source more parts from North America and face an increased compliance burden.
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