Rules of Origin in Free Trade Agreements

Significant tariffs are currently being imposed on international trade between China and the United States, which effectively blocks direct trade between the two countries.

These tariffs however, do not eliminate the possibility of indirect trade between the two countries, by shipping goods through third countries. Of course, shipping Chinese finished goods to the United States and labelling them, for example, as products manufactured in South Korea, is prohibited and constitutes an offense. There is a middle ground between direct and indirect trade, such as if particular product components are manufactured in China, while other components are manufactured in other countries, such as Israel. In such case, the finished goods will benefit from a lower tariff.

In recent weeks, imports to the United States have become an extremely complicated process, with the tax rate calculated according to the following categories:

1. Products from countries that are not members of the World Trade Organization – the tariff to apply will vary from product to product and country to country. A basic 10% surcharge was added to all previous tariff rates on April 5, 2025. Furthermore, the United States announced that, within 90 days of April 10, the US will impose special reciprocal tariffs on particular countries with a large trade deficit with the United States. These tariffs will be added to the existing tariffs.
2. Products from WTO member countries – these countries are subject to the “most preferential country” rule. According to this rule, the United States imposes tariffs on each product separately, but the tariff rate on each product must be the same among all WTO member countries. On April 5, 2025, a 10% surcharge was added to this tariff for all countries. If a country does not reach an agreement with the United States within 90 days, additional special tariffs will be added. The tariff imposed on China is currently at a rate of 145%.
3. Products from countries that signed a free trade agreement with the United States (such as Mexico, Canada, Israel and Chile). Almost all products imported to the US from these countries were exempt from customs duties. As of April 5, a 10% tariff was imposed on all imported products, excluding products from Mexico and Canada. Countries that do not reach an agreement with the United States within 90 days will be subject to additional special tariffs.

Rules of origin are used to determine if products are eligible for exemptions from customs duties or reduced duties under the FTA rules even if they contain non-FTA components.  

The rules determining country of origin can be very simple if a product is manufactured and assembled primarily in one country. However, when a finished product includes components that originate in many countries, determining origin can be more complex. Rules of origin can be very detailed and specific, and vary from agreement to agreement and from product to product. 

The general rule accepted by the US customs authorities is the “substantial transformation” rule. According to this rule, a product that contains components from more than one country is classified as a product of that country where the product underwent a fundamental transformation into a new and different product with a different name, form, appearance, nature or mode of use that is distinct from the component or material from which it was transformed.

This rule is examined on a case-by-case basis, and the US customs authorities are afforded broad discretion. Nevertheless, assembling a product using various pre-prepared components – and certainly mere repackaging – do not fulfill the criteria to be deemed a “substantial transformation.”

In other words, according to the Rules of Origin, raw materials or various machine components may be imported from China, but in order for the product to be classified as an Israeli product, a substantial part of the manufacturing processes must be carried out in Israel.

Israel and the United States have a free trade agreement that specifies that products manufactured in Israel and exported to the United States will not be subject to customs duties. The special reciprocal tariffs (currently at 17%) will apply in any case, but products imported from Israel will not be subject to any additional tariffs. However, in order for a product to be classified as an Israeli product for the purposes of the free trade agreement, the US imposed an additional “substantial transformation” condition on Israel: manufacturing costs in Israel, including all costs that can be directly attributed to the product, must exceed 35% of the product value.

In other words, one can assume that up to 65% of the manufacturing and raw materials costs (not including profits) will be for components and raw materials originating in another country, and nevertheless, the product will be classified an Israeli product for the purposes of the agreement.

At the moment, it seems that the United States will continue adhering to these rules also in relation to President Trump’s new tariff policy.

As stated above, the Rules of Origin are quite complex. We recommend the obtaining of legal counsel in order to assess their applicability to each individual product.