Internal Advice Request; Fallback Method of Appraisement; Repaired/Inspected Merchandise

September 16, 2010 HQ H102516 OT:RR:CTF:VS H102516 YAG CATEGORY: Valuation Port Director U.S. Customs and Border Protection Port of El Paso 3600 East Paisano Drive, Bldg A El Paso, TX 79905 RE: Internal Advice Request; Fallback Method of Appraisement; Repaired/Inspected Merchandise Dear Port Director: This is in response to your request for internal advice, dated April 6, 2010, concerning the appropriate method of appraisement of Chinese-origin electric motors, repaired or inspected in Mexico and subsequently imported to the United States, by [***] (the “Importer”). We regret the delay in responding. The Importer has asked that certain information submitted in connection with this internal advice be treated as confidential. Inasmuch as the Importer’s request conforms to the requirements of 19 CFR §177.2(b)(7), the Importer’s request for confidentiality is approved. The information contained within brackets and all attachments to the internal advice request, forwarded to our office, will not be released to the public and will be withheld from published versions of this ruling. FACTS: The Importer manufactures and markets electric motors in North America. The Importer’s business operations consist of two (2) primary divisions: [***] (“Company X”) and [***] (“Company Y”). Company Y has manufacturing operations in China and Mexico. Electric motors are produced in both countries and imported to the United States. The electric motors imported to the United States are either shipped directly to customers’ facilities or are shipped to one of the Importer’s distribution centers in the United States. Upon importation, the electric motors are stored at the various distribution centers by part number. Once the motors are received and stored, any reference to the original importation data on the motor or pallet is typically lost. The motors may be commingled with other motors of the same part number and origin. Electric motors imported by [***] from China are entered using the computed value method of appraisement. The value declared on the invoice is the transfer price, which is based on estimated production, material costs, and an amount for profit in China. The transfer price is calculated by the Importer’s Business Analysis Manager, located at the Company Y’s headquarters in the United States. The Importer uses computed method of appraisement because the price of the electric motors imported from China is influenced by the relationship of the parties. Adjustments to the transfer price may be made periodically based on target profitability levels, determined by the most recent independent transfer price study. Duty is paid based on the transfer price at the time of entry, and the entries are flagged for reconciliation. An annual reconciliation entry is submitted for all entries from each manufacturing facility during the period. This reconciliation entry includes adjustments made to the entered value to account for fluctuations in material and labor costs and other costs associated with the manufacture of electric motors in China. After importation, the Chinese-origin electric motors may require inspection or repair, due to a quality issue with a particular component, raw materials, or a quality issue identified by customers. Thus, rather than ship the Chinese-origin electric motors back to China for repair or inspection, [***] ships the motors to its manufacturing facilities in Mexico. The repair and/or inspection of the Chinese-origin electric motors is done at one of [***] wholly owned subsidiary companies in Mexico. The groups of motors are kept separate by part numbers and country of origin, but are otherwise commingled. Any parts or components used in the repair process are taken from general inventory of parts used in the motor production process of the plant. The labor hours that are spent or used in Mexico to repair or inspect the Chinese-origin motors are calculated and charged to the Chinese plant at the actual labor rates plus a percentage for benefits. Additionally, any special tools purchased specifically for the repair or inspection operations, inventory parts, and scrap are charged to the Chinese plant. These charges are made on a monthly basis for all activity during the previous month. The amounts for labor and benefits are not known until the books are closed for the month. There is no direct payment made by any entity to the Mexican plant for the repair or inspection work. The charges explained above reduce the conversion cost that is booked on the Company Y’s corporate books for the plant. Once the repair/inspection in Mexico is complete, electric motors are imported to the United States from Mexico and placed in inventory at the U.S. distribution centers. If the repaired/inspected motor is specifically designed for a particular customer, then the motor goes back to that customer. If the repaired/inspected motor is designed for general use, then it can be sold to other customers. After importation from Mexico, the repaired/inspected motors are commingled with other motors imported from China with the same part number. According to the Importer, there is no way for the warehouse personnel to identify which motors have been inspected or repaired and which motors were imported directly from China and did not undergo inspection or repair. The motors are stored using the first-in, first-out (“FIFO”) inventory method. The Importer believes that the appropriate method of appraisement is the “fallback” method as described in 19 U.S.C. §1401a(f). Currently, after repair/inspection the motors that are not scrapped are valued on the company’s books at the U.S. standard cost. The U.S. standard cost is comprised of the following elements: Chinese manufacturer’s standard costs (converted from RMB’s to USD’s at an annual Plan exchange rate) + ocean freight and estimated U.S. duties. Additionally, the manufacturer’s standard cost of the motors produced in China is the transfer price between the Chinese manufacturer and the Importer in the United States. ISSUE: What is the appropriate method of appraisement for the Chinese-origin electric motors that are returned to the United States from Mexico after inspection and/or repair? LAW AND ANALYSIS: Merchandise imported into the United States is appraised for customs purposes in accordance with Section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. §1401a). The primary method of appraisement is transaction value, which is defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable. See 19 U.S.C. §1401a(b)(1). In this case, the Importer owns the electric motors at the time of the exportation of the merchandise to Mexico for a repair and/or inspection. The electric motors are subsequently returned to the United States. This importation is not the result of a sale, and, thus, there is no sale for exportation to the United States. Consequently, the subject merchandise cannot be appraised on the basis of transaction value. When transaction value is eliminated as the appropriate method of appraisement, imported merchandise must then be appraised in accordance with the remaining methods of valuation, applied in sequential order. 19 U.S.C. §1401a(a). The alternative bases of appraisement, in order of precedence, are: the transaction value of identical or similar merchandise (19 U.S.C. §1401a(c)); deductive value (19 U.S.C. §1401a(d)); computed value (19 U.S.C. §1401a(e)); and, the “fallback” method (19 U.S.C. §1401a(f)). The transaction value of identical or similar merchandise is based on sales, at the same commercial level and in substantially the same quantity, of merchandise exported to the United States at or about the same time as the merchandise being appraise. The Importer indicates that this valuation method does not apply because there are no shipments of repaired and/or inspected merchandise for which transaction value is the method of appraisement. Therefore, there is no previously accepted transaction value. We accept the Importer’s argument and find that it is indeed impossible to appraise the repaired/inspected electric motors on the basis of the transaction value of identical or similar merchandise. Under the deductive value method, imported merchandise is appraised on the basis of the price at which it or identical or similar merchandise is sold in the United States in its condition as imported and in the greatest aggregate quantity either at or about the time of importation, or before the close of the 90th day after the date of importation. 19 U.S.C. §1401a(d)(2)(A)(i)-(ii). This price is subject to certain enumerated deductions. 19 U.S.C. §1401a(d)(3). The Importer advises that deductive value does not apply for this transaction because the inspected/repaired motors from Mexico are typically commingled with other motors of the same part number after importation into the United States. Therefore, according to the Importer, it is not possible to determine the date of sale to unrelated parties of the imported motors after they have been commingled with other motors in the distribution centers. We are not persuaded by this argument. The Importer’s analysis overlooks the fact that in order to appraise the merchandise under the deductive value method, the U.S. resale price of merchandise that is identical or similar to the imported repaired/inspected motors being appraised may be used. See Headquarters Ruling Letter (“HRL”) W563557, dated December 26, 2006 (under deductive value the domestic sale of merchandise that is identical or similar to the merchandise being appraised may qualify the goods for appraisal under this method). In other words, the Importer does not have to use the resale price of the exact inspected/repaired motors from Mexico; instead, the Importer can use the resale price of other repaired motors in its inventory. The Importer states that once the repair/inspection in Mexico is complete, electric motors are imported to the United States from Mexico and placed in inventory at the U.S. distribution centers. Further, if the repaired/inspected motor is specifically designed for a particular customer, then the motor goes back to that customer. If the repaired/inspected motor is designed for general use, then it can be sold to other customers. However, the motors are stored in the Importer’s warehouses using the FIFO inventory method, based on the date of arrival at the warehouse. Therefore, once repaired and stored in the warehouse, the inspected/repaired motors are commingled with new motors and may be sold together. Further, the motors may be sold soon after the importation, or as much as five years after the importation. Moreover, the Importer informs us that the Importer is not able to calculate the profits and general expenses under the deductive value method of appraisement at this time. Thus, even though we know that domestic sales of the inspected/repaired motors occur, because the Importer commingles the new motors with the inspected/repaired motors, and it appears that these domestic sales may occur as much as five years after the importation, with no information available as to the profit or general expenses of the Importer, the application of the deductive method of appraisement under 19 U.S.C. §1401a(d) is precluded in this instance. The next method of appraisement is computed value. Under this method, merchandise is appraised on the basis of the material and processing costs incurred in the production of imported merchandise, plus an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind, and the value of any assists and packing costs. 19 U.S.C. §1401a(e). The Importer indicates that the computed value method of appraisement does not apply because the electric motors entering Mexico cannot be traced back to their original entry from China. Additionally, the production costs in China are sometimes not known until 21 months after entry from China. Finally, the repair or inspection costs incurred in Mexico cannot be determined, since the motors are commingled by part number and are repaired on the same production line as other motors of Mexican origin. That being the case, we agree that the repaired/inspected electric motors of Chinese origin cannot be appraised under computed value. The remaining appraisement method is the fallback method, in accordance with 19 U.S.C. §1401a(f). This method provides that merchandise should be appraised on the basis of a value derived from one of the prior methods, reasonably adjusted to the extent necessary to arrive at a value. The Importer proposes appraising the repaired/inspected motors on the basis of the U.S. standard cost, which included the following elements: Chinese manufacturer’s standard costs (converted from RMB’s to USD’s at an annual Plan exchange rate and provided to the plant in Mexico on an annual basis) + ocean freight and estimated U.S. duties. The Importer claims that this is a variation of the computed value method of appraisement of the Importer’s merchandise. Indeed, it appears that the method the Importer uses to determine the U.S. standard cost is similar to the computed value method of appraisement. However, the Importer’s proposed method contains the U.S. customs duties and ocean freight, appearing on the books of the Importer. The U.S. customs duties, appearing on the books of the Importer, are not considered general expenses of the producer and, thus, do not need to be included in the value of the repaired/inspected electric motors. With respect to the inclusion of the ocean freight, unlike the treatment of transportation charges under transaction value and deductive value methods of appraisement, specified in 19 U.S.C. §1401a(b) and 19 U.S.C. §1401a(d), there are no regulations or statute in existence concerning the treatment of transportation costs for computed value or, in this case, the fallback method of appraisement derived from the computed value method. Therefore, we must next look to CBP or court interpretation. In Campbell Soup Company, Inc. v. United States, 853 F.Supp. 1443 (Ct. Int’l Trade 1994), the Court of International Trade held that because the producer of the merchandise recorded freight costs as a general expense in its financial records and because this treatment was consistent with generally accepted accounting principles in the country of exportation, freight costs had to be included in arriving at computed value. The Campbell Soup Company case affirmed the position taken by CBP in HRL 544344, dated November 14, 1990. However, in this case, the ocean freight charges are not incurred by the producers of the merchandise, and since these transportation costs are not recorded as a general expense on the producers’ books, we find that these costs are not part of the valued of the imported merchandise under 19 U.S.C. §1401a(f), derived from the computed value method of appraisement. Therefore, in the absence of other information and due to the inability of the Importer to determine the repair costs and track the electric motors originating in China and Mexico, the imported merchandise should be appraised on the basis of Chinese manufacturer’s standard costs (converted from RMB’s to USD’s at an annual Plan exchange rate) under 19 U.S.C. §1401a(f). HOLDING: The Chinese-origin electric motors that are returned to the United States from Mexico after inspection and/or repair should be appraised using the fallback method of appraisement under 19 U.S.C. §1401a(f) on the basis of the Chinese manufacturer’s standard costs. This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, the Office of Regulations and Rulings will make the decision available to CPB personnel, and to the public on the CPB Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.   Please do not hesitate to contact us at (202) 325-0042 if you have any questions or concerns. Sincerely, Monika R. Brenner, Chief Valuation & Special Programs Branch