The automotive industry in Canada took a collective sigh of relief on September 30, 2018 when a free trade agreement was reached with the United States and Mexico, effectively nullifying President Trump's widely threatened 25% tariff on automobiles.
In the lead up to the U.S. imposed deadline, auto dealer principals across the country raised their collective voices through the Canadian Automobile Dealers Association and joined the Canadian Chamber of Commerce's Coalition to Keep Trade Free. Together they cited the devastating effects such tariffs would have on dealers, who currently employ more workers than vehicle, truck, and parts manufacturing.
Faced with what could have been the devastation of an industry, the measures eventually agreed upon by the three countries appear positive. What is less certain is how these yet to be ratified changes will ultimately affect automotive dealerships and the landscape of car sales in Canada.
It's no secret that the industry is undergoing some significant shifts, from electrification and connectivity, to shared mobility and shifting buying preferences, the business of selling cars is becoming more complex. But how will the new USMCA play into this landscape, and what are the potential effects?
Firstly, let's understand the deal.
The Deal
Vehicle North American Content Requirements
Under the current NAFTA, most vehicles require 62.5% content (materials) from either the U.S., Canada, or Mexico to qualify for duty-free entry into one of the other party countries. This content threshold will rise to 75% and must contain at least 70% North American steel and aluminum content under the USMCA. There will also be a new labour content provision that requires 40% to 45% of auto parts manufacturers' activities be carried out by workers who make US$16 or more per hour. The rise in labour and material content requirements will be phased in over a three- to five-year period.
Section 232 U.S. Import Tariffs on Canadian Manufactured Automobiles
The USMCA secures a commitment from the U.S. that they will provide at least a 60-day exemption period on any future tariffs, including those on automobiles, under section 232 of the Trade Expansion Act of 1962. This would allow time for negotiation with the U.S. before any such additional tariffs are entered into force. The U.S. government will allow a quota of vehicles to enter duty free before the additional tariffs are applied if negotiations still result in the application of section 232 tariffs.
The Effects
Vehicle manufacturers will immediately be reviewing their supply chain to assess potential compliance issues. They will be looking to their suppliers to provide materials with the increased North American material content threshold of 75%, enabling their vehicles to qualify for duty free treatment under USMCA. In addition, they will be reviewing their payroll to determine how to manage the increased wage requirements.
Although the intent of these requirements on paper is to re-shore lost manufacturing jobs to Canada and the U.S., whether they do in practice remains to be seen. Like many multi-lateral agreements, the devil is often in the details; what is not mentioned is that punitive costs for Mexican plant non-compliance remains at just 2.5%, and a process for enforcing the new requirements has yet to be determined. For those reasons alone, it may take longer for the updated Rules of Origin to incentivize the return of manufacturing jobs to Canadian and U.S. shores.
For the section 232 tariffs on Canadian manufactured vehicles, the quotas written into the deal far exceed any future foreseeable amounts that Canadian vehicle manufacturers are forecasting to export to the U.S. That means the threat of additional tariffs on future imports is very slight, making the reactionary Canadian surtax countermeasures also extremely unlikely.
The Future for Automotive Dealers
Although the deal, for the time being, preserves existing North American supply chains, the compliance costs of USMCA are likely to make manufacturing vehicles ultimately more expensive. The increased costs will need to be born by someone, and although it remains to be seen how manufacturers will respond, the options are limited.
Among the most likely scenarios: the expense will be transferred directly to the consumer, effectively putting auto dealers under further pressure to sell increasingly more expensive cars to a cost conscious audience.
In 2017 Canadian auto sales topped 2 million units for the first time, and even though 2018 has not seen the same level of activity, the year will likely close out not too far behind at around 1.9 million units. Adding a cost increase to the other industry trends looming on the horizon will make keeping up with these kinds of sales numbers increasingly challenging for dealers and their teams. Lower unit sales mean leaner dealerships, and failing to reach projected unit sales can have far reaching consequences with the manufacturer.
Ultimately, dealers will need to be mindful of their expenses, and look for cost efficiencies in other areas of their business to free up space for cost competitiveness vis-à-vis the competition. Dollars count, even the small ones, and perceptive retailers will put a plan in place now that can be phased in over the next three to five years as the effects of USMCA are felt in the industry.
For a complete breakdown of the USMCA and its impact on Canadian industries, read our Tax alert – What will change in the move from NAFTA to USMCA?
Author
Shane Weimer
Western Leader, Automotive Retail
Expert Contributor
Charmaine Goodeeris
Senior Manager, Customs and International Trade