G/RO/W/202  
 
30 October 2020 
(20-7693) Page: 1/6 
Committee on Rules of Origin  Original: English  
 
 
SUBMISSION OF LDC TO THE COMMITTEE ON RULES OF ORIGIN  
AD VALOREM  CRITERION  
COMMUNICATION FROM THE LDC GROUP  
The following submission, dated 30 October  2020, is being circulated at the request of the LDC 
Group . 
 
_______________  
 
 
1  INTRODUCTION  
1.1.  As pointed out in a previous submission by the LDC Group1, almost five years have now passed 
from the adoption of the Nairobi Decision on preferential rules of ori gin for LDCs. Some  progress has 
been recorded in achieving better transparency trough the adoption of a notification template and 
the calculation of utilization rates of the Duty Free and Quote Free (DFQF) schemes. However there 
has not been parallel progress in implementing the substantive part of the Nairobi Decision, more 
precisely the paragraphs concerning the substantial transformation and certification requirements. 
As we are now almost past the 5th anniversary of the Nairobi Decision an d we are heading for a new 
WTO ministerial possibly in 2021 it is of paramount importance to make concrete progress. It is now 
time to focus the debate in the Committee on Rules of Origin (CRO) on how to effectively implement 
the substantive aspects of the  Nairobi Decision on preferential rules of origin for LDCs.  
1.2.  As previously stated,  the LDC Group intends to progressively bring to the attention of the CRO 
the substantive aspects  of rules of origin of preference granting countries that needs reform by 
contrasting them with the relevant paragraphs of the Nairobi Decision and identified best practices. 
The ultimate goal is to achieve better utilization of DFQF  schemes  and the attainment of the 
sustainable development goals ( SDGs), namely SDG 17 target 17.12: Ensuring that preferential 
rules of origin applicable to imports from least developed countries are transparent and simple and  
contribute to facilitating market access.  
1.3.  In order to focus the debate , the LDC Group will submit a series of technical notes on each of 
the methodologies to define substantial transformation, namely (a) ad valorem  percentage criterion ; 
(b) change of tariff classification2; and  (c) specific working or processing as well as cumulation and 
certification procedure.  
1.4.  This note, without being exhaustive, examines the use of the ad valorem  percentage by 
preference -giving countries contrasting existing rules  with the relevant paragraphs of the Nairobi 
Decision and list ing some best practices and area s for improvement.  
 
1 See G/RO/W/194 of 5 March 2020.  
2 A presentation on the change of tariff classification (CTC) has already been made by the LDC Group 
(RD/RO/72). The presentation has been substantiated by a submission by the LDCs (See G/RO/W/184) that 
identified a number of examples where the CTC has been used by some preference -giving Countries in a 
non-consistent manner with the Nairobi Decision. Bilateral meetings have been held with the EU and Japan to 
discuss how such inconsistencies could be resolved. The LDC Group will resume as soon as possible the 
meetings with these two Members and report the results to the CRO.  G/RO/W/202  
 
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  1.2  Substantial Transformation when Applying an ad valorem  Percentage Criterion: 
Recalling Paragraph 1.1 of the Decision  
1.5.  On the ad valorem percentage criterion to determine substantial transformation, the Nairobi 
Decision provides that preference -granting Members  shall:   
"Adopt a method of calculation based on th e value of non -originating materials . 
However, Preference -granting Members applying another method may continue to use it. It is 
recognized that the LDCs seek consideration of use of value of non -originating materials by 
such preference -granting Members wh en reviewing their preference programmes.  
 
Consider, as the preference -granting Members develop of build their individual rules of origin 
arrangements applicable to imports from LDCs, allowing the use of non -originating 
materials up to 75% of the final value of the product , or an equivalent threshold  in 
case another  calculation method is used, to the extent it is appropriate and the benefits of 
preferential treatment are limited to LDCs.  
 
Consider the deduction of any costs associated with the transportation and 
insurance of inputs from other countries to LDCs  (empha sis added )." 
 
1.6.  Accordingly,  the issues to be considered are threefold:  
(a) With the exception of Australia; New Zealand;  Chinese Taipei ; and the US, all 
preference -granting Members  are using a method of calculation based on a value of 
non-originating materials. A  positive development would be the adoption by the US and other 
Members  mentioned above of a method of calculation based on value of non -originating 
materials. It has to be noted in fact that the US , as well as the other preference -giving 
countries , consistently use a methodology based on value of materials in all FTAs of recent 
generation;  
(b) With the notable exception of Canada,  no other preference granting Member  currentl y allows 
a percentage of non -originating materials of up to 75% of the final value of the product;  
(c) None of the preference -granting Members  allow the deduction of costs associated with 
transportation and insurance and/or provisions are unclear on this v ital issue . 
 
1.7.  In addition , there are horizontal issues that need to be considered to carry out a balanced 
analysis of the use of ad valorem  percentage criterion by preference giving namely but not limited 
to: (1) extent of the cumulation granted under each preferential arrangement ; and  (2) the existing 
practices of a preference -granting country under other preferential agreements.  
1.8.  In fact , the quantitative ( with what other countries is possible to cumulate?) and qualitative 
(full or diagonal) extent of the c umulation that preference granting countries allow under each 
individual scheme play a role on the restrictiveness or leniency of an ad valorem  percentage. 
This holds true also for other drafting techniques such as CTC and specific working or processing,  
but it becomes particularly evident when using an ad valorem  percentage criterion applied across 
the board i.e. to all products. It has also been observed that modern rules of origin contained in 
FTAs show that the percentage criterion is mostly used in combination with a CTC and is seldom 
used as a standalone criterion. The maintenance of an unaltered stand -alone ad valorem  percentage 
criterion from 1974 in the case of the US onwards can be hardly considered a best practice especially 
when there are stro ng indications and findings that such ad valorem  percentage is not trade creating 
(as the LDC Group has been indicating since 20143). 
1.9.  Another important aspect is that some preference -granting Members have adopted more 
lenient rules of origin for the same products under FTAs that they have negotiated with other 
partners and/or they adopted existing best practices under other FTAs on how substantial 
 
3 See "Acc ounting Underutilization of Trade Preference Programs: The U.S. Generalized System of 
Preferences" by Shushanik Hakobyan Middlebury College, August 2012, and the previous submission by the 
LDC Group, see "Challenges Faced by LDCs in Complying with Preferen tial Rules of Origin under Unilateral 
Preference Schemes" paper presented by Uganda on behalf of the LDC Group (document G/RO/W/148 dated 
28 October  2014).  G/RO/W/202  
 
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  transformation could be achieved adopting less stringent requirements. Th is observation reveals  
that some pref erence -giving Members hesita te to engage in the necessary reforms to implement 
more flexible rules of origin for LDCs and adhere to the spirit of the Nairobi Decision.  
1.10.   This note addresses point (a) and point (c) above namely the methodology of the ad valor em 
percentage calculation and the issue of insurance and freight of non -originating materials. Point (b), 
the level of percentages, will be the subject of a separate note given the relevance of the topic.   
1.11.   Table 1 below summarizes the current practices of the different preference -granting Members.  
Table 1: Summary of the Use of ad valorem  Percentage by Preference Giving Countries  
Country  Percentage 
Level Numerator  Denominator  Use of 
VNOM  Deduction of 
insurance and 
freight  Gap from 
the Nairobi 
Decision  
Australia  Value added by 
addition (50%)  Allowable factory 
cost Ex-factory 
cost No N/A  25% + IFI  
Canada  Max. VNOM 
60% for LDCs 
(80% applying 
cumulation)  VNOM  Ex-factory 
price Yes No IFI 
Chile Calculation by 
subtraction of 
non-originating 
materials 
(50%)  FOB price - VNOM  FOB price  Yes N/A 25% + IFI  
China  Min. value 
added by 
subtraction 
40% Price of goods 
minus the price of 
materials originating 
from the beneficiary 
country  FOB price  Yes No 15% + IFI  
European 
Union (EBA)  Max. VNOM 
70%*  VNOM  Ex-works 
price Yes No/unclear  5% + IFI  
Eurasian 
Economic 
Union  Max. VNOM 
55%4 Customs value**  Ex-works  
price? **  Yes No 20% + IFI  
India Min. 30% value 
added by 
subtraction  FOB price minus the 
VNOM  FOB price  Yes No 5% + IFI  
Japan  Max. VNOM 
40%*  VNOM  FOB price  Yes Unclear  35% + IFI  
New Zealand  Value added by 
addition (50%)  Cost of materials + 
expenditures in 
other items of 
Factory or work cost 
in New Zealand or 
LDCs Ex-factory 
cost No N/A  25% + IFI  
Norway  Max. VNOM 
70% VNOM  Ex-works 
price Yes No 5% + IFI 
South Korea  Max. VNOM 
60% VNOM  FOB price  Yes No 15% + IFI  
Switzerland  Max. VNOM 
70% VNOM  Ex-works 
price Yes No 5% + IFI 
Chinese 
Taipei  Value added by 
addition (50%)  Production process  FOB price  No N/A  25% + IFI  
Thailand  Calculation by 
subtraction of 
non-originating 
materials 
(50%)  FOB price - VNOM  FOB Price  Yes N/A  25% + IFI  
 
4 See Decision No. 60 of the Council of the Eurasian Economic Commission dated 14 June 2018. G/RO/W/202  
 
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  Country  Percentage 
Level Numerator  Denominator  Use of 
VNOM  Deduction of 
insurance and 
freight  Gap from 
the Nairobi 
Decision  
United 
States  (GSP 
& AGOA)  Min. 35%  Cost of materials 
produced in 
preference -receiving 
country plus the 
direct cost of 
processing carried 
out there  Appraised 
value of the 
article at the 
time of entry 
into the 
United 
States  No No 10% + IFI and 
methodology 
of calculation  
Note:  Most used percentages, **English translation of the legal text not available, VNOM: Value of 
Non-Originating Materials, IFI: Issue of Freight and Insurance; N/A: Not Applicable.  
1.3  Discussion on non -conforming ad valorem  percentages Rules of Origin and practices 
by preference granting countries  
1.12.   The LDCs wish to bring to the attention of preference -granting Member a series of issues that 
are not in conformity with the spirit and the letter of the Nairobi decision as follow s: 
1.3.2   Use of a methodology for the calculation of the ad valorem  percentage criterion 
different from a value of materials methodology ; 
1.13.   As illustrated previously by the LDC Group and in recent literature5 there are different 
methodologies for the calculation of the ad valorem  percentage. The methodology used by Australia; 
New Zealand; Chinese Taipei ; and the US uses what is commonly defined a value -added  calculation 
by addition as shown below:  
a) Value added calculation by addition  
 
𝐷𝑖𝑟𝑒𝑐𝑡  𝑐𝑜𝑠𝑡  𝑜𝑓 𝑝𝑟𝑜𝑐𝑒𝑠𝑠𝑖𝑛𝑔 +𝑣𝑎𝑙𝑢𝑒  𝑜𝑓 𝑜𝑟𝑖𝑔𝑖𝑛𝑎𝑡𝑖𝑛𝑔  𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙
𝐴𝑝𝑝𝑟𝑎𝑖𝑠𝑒𝑑  𝑣𝑎𝑙𝑢𝑒  (𝑒𝑥−𝑓𝑎𝑐𝑡𝑜𝑟𝑦  𝑝𝑟𝑖𝑐𝑒 )= …% 
1.14.   Paragraph 1.1 of the Nairobi decision calls for the adoption of a methodology for the 
calculation of the ad valorem  percentage based on the value of non -originating materials that could 
be expressed as follows:    
b) Value  of material calculation  
 
i. Value ad ded by subtraction of non -originating materials:   
𝐸𝑥 𝑊𝑜𝑟𝑘𝑠  𝑣𝑎𝑙𝑢𝑒 −𝑉𝑁𝑂𝑀
𝐸𝑥 𝑊𝑜𝑟𝑘𝑠  𝑣𝑎𝑙𝑢𝑒= …% 
ii. Maximum value of non -originating materials:  
𝑉𝑁𝑂𝑀
𝐸𝑥 𝑊𝑜𝑟𝑘𝑠  𝑉𝑎𝑙𝑢𝑒= … % 
Where  
VNOM:  Value of non -originating materials;  
(Ex-Works is sometimes replaced by the FOB value)  
 
5 See "Convergence on the Calculation Methodology for Drafting Rules of Origin in FTAs Using the 
ad valorem  Criterion by Stefano Inama and Pramila Crivelli, Global Trade and Customs Journal, Volume 14, 
Issue  4 © 2019 . See also "The methodologies of drafting  the ad valorem percentage criterion " Existing 
practices in African RECs and way forward in AfCFTA Note drafted by the Division for Africa, Least Developed 
Countries and Special Programmes of the United Nations Conference on Trade and Development (UNCTAD) in 
preparation of the AfCFTA 7th Technical Working Group Meeting on Rules of Origin available at 
https://unctad.org/system/files/officialdocument/a ldc2018_AfCFTA_TWGRoO7_tn_advalorem_en.pdf  G/RO/W/202  
 
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  1.15.   It has been recognized in various instances6 that the methodology of calculation based on 
"value added calculation by addition " is not a best practice. The large majority of FTAs at present 
uses a value of material methodology.  
1.16.   In fact , the definition of direct processing costs is complicated as there is a distinction in the 
direct processing costs of manufacturing of a finished product that could be considered as value 
added as follows:  
(a) Items included in the direct costs of processing operations: like labour , dyes, mould , research, 
inspection ; and 
(b) Items not included in the direct costs of processing operations: like profit, general overhead 
expenses . 
1.17.   A simple search in the US customs ruling website ( https://rulings.cbp.gov/home ) reveals that 
there are around 375 to 800 records of rulings about the definition of direct costs  of processing. This 
is rather compelling evidence of the complexities involved in the definition and interpretation of 
processing costs.  The disadvantages of a value -added calculation by addition could be summarized 
as follows:  
• Itemization of costs to th e single unit of production : this  requires accounting, and some 
discretion remains in assessing the unit costs ; 
• Currency fluctuations may affect the results of the calculation ; 
• Low labour  costs in LDCs may result in low value s added locally (turning this i nto a 
disadvantage instead of being a factor of competitiveness for LDC producers ). 
• The value added -content requirement may necessitate the submission of additional evidence 
of manufacturing costs  (this may include product specifications, bills of material s, product cost 
sheets, payment records, overhead allocation schedules, raw material purchases, proof of 
factory labour , and support for manufacturing overhead );  
• Production records must establish the value of the materials used in the originating article on 
a lot-by-lot, batch -by-batch, shipment -by-shipment basis ; 
• Documentation and records supporting originating status must be verifiable by linkage to 
inventory and accounting records including summary records such as monthly production 
reports and accounts payable records.  
1.3.3   Adjustments to Value of non -originating materials -issue of deduction of cost of 
insurance and freight  
1.18.   In a calculation methodology based on the value of the non -originating materials as numerator 
as shown in (b) above , the computation of the value of such non -originating materials has a bearing 
on the outcome of the percentage calculation. This holds especially true when one consider s that 
the cost of insurance and freight of inputs for landlocked or island LDCs may be  almost equivalent 
to a third of the value of the shipment , if not more. Cost of insurance and freight of non -originating 
materials are exogenous factors depending on geographical locations and have little to do with 
substantial transformation.  
1.19.   The deducti on method suggested by LDCs is based on adjustments made to the value of 
non-originating materials allowing for  the deduction of insurance and freight costs from the customs 
value of non -originating materials. The deduction of the cost of insurance and fre ights from the value 
of non -originating materials ensures a fai rer calculation and may greatly facilitate compliance with 
the rules of origin for landlocked  (16) and island LDCs (11). 
1.20.   Consider the following example7: A manufacturer based in Lilongwe  (Mala wi) is manufacturing 
steel frames using imported steel tubes. The applicable RoO is a 70% allowance of non -originating 
materials. The manufacturer purchase steel tubes from China to manufacture the steel frames for 
USD 10,000. After manufacturing the steel  tubes into steel frames by cuttings, soldering, 
 
6 Ibidem, footnote 5.  
7 Example from "The methodologies of drafting the ad valorem  percentage criterion " Existing practices 
in African RECs and way forward in AfCFTA Note drafted by the Division for Africa, Least  Developed Countries 
and Special Programmes of the United Nations Conference on Trade and Development (UNCTAD) in 
preparation of the AfCFTA 7th Technical Working Group Meeting on Rules of Origin available at 
https://unctad.org/system/files/officialdocument/aldc2018_AfCFTA_TWGRoO7_tn_advalorem_en.pdf . G/RO/W/202  
 
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  galvanizing, coating the manufacturer sell s the frames sold to a South African importer at an 
ex-works price of USD 16,000. It follows the value -added calculation below:  
10,000
16,000=0.625 =62.5% < 70% 
 
The frames are therefore originating.  
 
1.21.   However, if the value of non -originating material is based on a CIF basis , the cost of insurance 
and freight from China to Lilongwe , an average of USD 1,250 for ocean freight and USD 3,600 for 
inland8 transport has to added to the cost of purchasing the container of steel tubes. Thus, the 
calculation will be as follows:  
10,000 +3,600 +1,250 =14,850  𝑈𝑆𝐷   
 
14,850
16,000=0.928 =92.8% > 70%  
 
1.22.   The frames are in this case largely exceeding the threshold of 70%.  
Table 1: Example of the relevance of Freight and Insurance  
 Without  Freight and Insurance  With Freight and Insurance  
(a) Foreign Materials  10,000  10,000  
(b) Ocean Freight  1,250 1,250 
(c) Inland Freight  3,600 3,600 
(d) Ex-Works Price  16,000  16,000  
(e) Value Added Calculation  𝑎
𝑑=10000
16000×100% 
 
=𝟔𝟐.𝟓%<70% 𝑎+𝑏+𝑐
𝑑=10000 +3600 +1250
16000
×100% 
 
=𝟗𝟐.𝟖%>70% 
Rule Satisfied?  YES NO 
 
1.23.   As can be seen from this illustration, t he exorbitant cost s of transport and insurance are 
crippling any effort to comply with the ad valo rem percentage requirement.    
1.4  Initial expectations of the LDCs on the implementation of the Nairobi decision on 
ad valorem  percentage  
1.24.   As a result, LDCs expect the following bes t practices to be implemented by preference -
granting Members : 
• Whenever it is used, the method of calculation should be based on value of materials 
methodology and based o n the value of non -originating materials out of the ex -works price or 
(FOB).9 
• Austra lia; New Zealand; Chinese Taipei ; and the US are called to introduce the necessary 
reforms in their Rules of origin to adhere to such best practice.  
• All preference giving countries using this method of calculation should allow for the deduction 
of the costs of insurance and freight from the value of non -originating materials.  
 
__________  
 
8 UNCTAD estimates based on field visits.  
9 It is noted that  in some sectors other methodologies such as CTC and Specific working or processing 
may be used as recent practices in FTAs have shown to better reflect the processing stages of the global value 
chains.