By Promit Mukherjee
OTTAWA (Reuters) -Steve Mallia's Toronto-based telescope accessory business was thriving until March when the Trump administration imposed a 25% tariff on U.S.-bound orders that do not comply with local content rules under the U.S.-Mexico-Canada Agreement.
The tariff, imposed soon after U.S. President Donald Trump took office in January, effectively stopped Mallia's StarField Optics from competing in its main market, as many of the components used in its products came from China.
"When we started to sell into the U.S., business was very strong. We were making money," Mallia said. "As soon as the tariff started to really take place, that disappeared."
Mallia, who founded his company in 2018, quickly decided his company's best hope of surviving was to make his products compliant with USMCA, the 2018 trade deal that replaced the North American Free Trade Agreement.
Tough decisions small businesses like Mallia must now make highlight the uneven consequences of Trump's efforts to upend the global trading order.
While the existing trade deal means Canada and Mexico have so far been less impacted by Trump's tariffs than many other economies, there are hundreds of small and medium companies in Canada that face a direct hit for not being USMCA compliant.
Small and medium businesses represent almost 98% of all firms in Canada and account for over 50% of the economy, according to government data.
Mallia said production changes to accomplish compliance came at a heavy cost: six months of lost sales, along with additional expenses to set up the factory, alter his supply chain and ramp up production.
Even so, a cost-benefit analysis convinced Mallia that it was money well spent. The changes will allow him to regain access from October to a market that has accounted for about 60% of StarField's sales, he estimates.
Mallia started the transition well before Thursday, when Trump hiked tariffs to 35% from 25% on goods imported from Canada that do not comply with the free trade deal.
Canada's steel, aluminum and auto sectors are particularly hard hit as they face separate tariffs between 25% and 50%. Adding to the uncertainty, USMCA is up for renegotiation next year.
To be compliant, companies such as StarField must prove that they generate a bulk of their products within the U.S., Mexico or Canada, or they have substantially altered an imported product in one of the three countries.
In Canada, a failure to comply with the trade deal means no or costly access to the world's biggest economy.
"Some companies are just not able to do that (comply), and some companies will not be able to do that in the short term," said Clifford Sosnow, partner and chair of the international trade and investment group at Fasken, a Canadian law firm.
OIL EXPORTS DUTY FREE
About 92% of Canadian exports by value entered the U.S. tariff-free in June because they were exempt, data from the U.S. Census Bureau showed. However, that figure is skewed by oil and gas shipments, Canada's top export by far, since almost 99% of oil shipments entered the U.S. duty free in June.
Without oil and gas, total tariff-free imports into the U.S. from Canada fell by six percentage points in June on a yearly basis - to 89% from 95%.
Oil producers and other larger exporters have the resources to ensure USMCA compliance, unlike smaller firms such as Mallia's.
The amount of Canadian exports that are officially USMCA compliant jumped by 20 percentage points in April to 56%, but has remained nearly unchanged since then, an analysis of U.S. Census Bureau data released on Tuesday showed.
The oil sector, which accounts for close to a third of Canada's exports to the United States, quickly adapted, with USMCA compliance rising to 84% in June from 25% in the same period a year ago.
Adding all other free trade provisions such as goods shipped directly to free trade zones or free trade bilateral agreements, more than 99% of Canadian oil exports enter the U.S. duty-free, U.S. Census Bureau data showed.
But outside of the oil and gas sector, compliance has only moved three percentage points to 45% in June from 42% the same month last year, suggesting that companies are struggling to meet USMCA rules to evade tariffs.
The Bank of Canada assumes that over the next two years 95% of Canadian goods exports are likely to be USMCA compliant, though lawyers and export consultants say the increase in compliance from the current level will not be quick.
Sectors struggling to comply with the trade deal and earn exemptions include exporters of live animals, meat, vegetables, cereals, chemicals and furniture, U.S. census data shows.
For many smaller companies, achieving compliance requires changing supply chains established decades ago, hiring legal counsel and documenting their production cycle for months or even years, said Sosnow from Fasken.
Barry Appleton, a professor at New York Law School and an international trade expert, said he expects more Canadian companies will become compliant, but very slowly and at a heavy cost that they will eventually pass on to customers.
"The low-hanging fruit has been picked," he said.
Mallia is looking to ramp up sales to Europe and Australia, but knows he cannot ignore the U.S. market. He is resigned to paying the high cost to resume shipping duty-free.
"At the end of the day, they're the biggest economy in the world, and they're right there," he said. "You are foolish not to look at that."
(Reporting by Promit Mukherjee; Additional reporting by Amanda Stephenson in Calgary and Fergal Smith in Toronto; Editing by Caroline Stauffer, Frank McGurty and Deepa Babington)
