Trade Compliance

GHY discusses changes to international trade regulations and explores cutting-edge compliance strategies.

“Substantial Transformation” in Determining the Origin of Drugs

Posted April 10, 2015

Determining a product’s country of origin is important for properly assessing tariffs, enforcing trade remedies (such as antidumping and countervailing duties) or quantitative restrictions (tariff quotas), and statistical purposes. Other commercial trade policies are also linked with origin determinations, such as country of origin labeling and government procurement regulations.

Non-preferential rules of origin are used to determine the origin of goods imported from countries with which the U.S. has most-favoured-nation (MFN) status, whereas preferential rules are used to determine the eligibility of imported goods from countries subject to free trade agreements (FTAs) and various trade preference programs. Preferential rules of origin are generally specific to each FTA or preference program and as such are variably defined.

Rules of origin can be very simple, noncontroversial tools of international trade where goods are wholly the growth or produce of a country or as long as all of the parts of a product are manufactured and assembled primarily in one country. However, when a finished product’s ingredients or component parts originate in many countries – as is often the case in today’s global trading environment – determining origin can be a very complex, sometimes subjective, and time-consuming process.

Among the different methods to establish the origin of a product incorporating parts or materials from different countries, the concept of “substantial transformation” is the one most typically employed. Substantial transformation is production that results in a new and different good, which then has a name, character, use, and tariff code different from those of its constituent materials. To better understand how substantial transportation occurs in the manufacture of chemical products such as pharmaceuticals, a recent decision by Customs and Border Protection (CBP) concerning the country of origin of a product known as Prepopik® is instructive.   

Prepopik® is an oral solution used to cleanse the bowel in preparation for colonoscopies. The product is manufactured in China with ingredients sourced from different countries. The U.S. importer Ferring Pharmaceuticals, Inc. argued that the only active pharmaceutical ingredient (“API”) in Prepopik® was sodium picosulfate which retains its chemical and physical properties and is merely put into a dosage form and packaged. The importer further contended that the processing in China does not result in a change in the medicinal use of the finished product.

However, after examining the manufacturing process and considering whether the final article retains the essential identity and character of the raw materials, the CBP determined otherwise. Customs found that the API sodium picosulfate was combined with another ingredient, magnesium oxide, an inorganic compound that occurs in nature as the mineral periclase and in aqueous media combines quickly with water to form magnesium hydroxide. It is used as an antacid and mild laxative and also has many non-medicinal uses. CBP noted that while individually both sodium picosulfate and magnesium oxide may be used to alleviate constipation, the combination of the two ingredients contributed to produce a more stimulative laxative effect for the product’s essential purpose of cleansing the bowels. In CBP’s view, the two ingredients were therefore “substantially transformed” when combined in China and, consequently, that China was the country of origin for Prepopik®.

Determining the proper country of origin of a product is not only critically important from a customs compliance standpoint in terms of avoiding penalties and the reputational damage that can increase chances of CBP audits or delayed customs clearance for future shipments, but is also key from the standpoint of preventing issues that might arise associated with packaging, labeling, or marketing processes which could result in adverse company costs should changes need to be made. Getting things right in the early stages of the product’s conceptualization and business planning stages by seeking professional advice and, if necessary, obtaining a binding ruling from CBP in advance, will help mitigate your risk and avoid costly problems down the line.