Response to Request for Internal AdviceRegarding U.S. Design and Development Costs

HQ W544192 June 16, 1989 CLA-2 CO:R:C:V W544192 DES Regional Commissioner Pacific Region Re: Response to Request for Internal Advice Regarding U.S. Design and Development Costs Dear Sir: This is in response to a request for internal advice, dated April 15 , 1988 (APP-6-01-O:TR), regarding the dutiability of United States design and development costs related to the production of a mold which is used in the manufacture of imported merchandise. FACTS: The importer or contract vendor in the United States designs and develops molds for injection of metal casting of parts to produce toys or toy parts which are manufactured either by the importer or related or unrelated U.S. or foreign vendors. One vendor may perform the design function, while another may construct the mold. Some of the mold design steps are as follows: --Determine the material and quantity to be used in construction. --Determine mold size. --Determine physical parameters of the mold. --Input above data into a computer to create the mold design. Once the mold is designed, the production mold is produced. These molds are then provided free of charge to the foreign manufacturer
The following scenarios have been presented by the concerned Customs officials as situations where the cost of the design and development functions come into question. The importer designs the mold and then supplies the mold drawings and specifications to a U.S. vendor who builds the mold and charges the importer for the mold construction. In another situation the mold may be fabricated in a foreign country by an unrelated firm or a firm related to the importer. The importer develops and supplies the drawings, specifications and prototypes to a U.S. vendor. The vendor then designs the mold to produce the part or toy. These designs, specifications and mold drawings are then supplied to another U.S. vendor, independent of the importer, who builds the mold. Each independent vendor invoices the importer for its services. In another scenario, the same situation is presented except the mold is fabricated in a foreign country by a firm related to the importer or the mold is fabricated by a firm unrelated to the importer. The importer develops and supplies the drawings, specifications and prototypes of a toy or part to an independent U.S. mold vendor to design and build the mold. The vendor then invoices the importer for the design and construction costs. Another situation to consider is where the unrelated U.S. designer has its related foreign facility construct the mold. ISSUE: Whether the United States mold design and development costs are part of the value of the molds. LAW AND ANALYSIS: The primary basis of appraisement is transaction value pursuant to section 402 (b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U. S.C. 1401 a (b)). Transaction value is defined as the "price actually paid or payable for the merchandise when sold for exportation to the United States plus certain enumerated additions, one of which is the value of any assist. Section 402 (h) of the TAA provides in relevant part for (the following: The term 'assist' means any of the following if supplied directly or indirectly, and free of charge or at reduced cost, by the buyer of imported merchandise for use in connection with the production or the sale for export to the United States of the merchandise: (i) Materials, components, parts, and similar items incorporated in the imported merchandise. (ii) Tools, dies, molds, and similar items used in the production of the imported merchandise. (iii) Merchandise consumed in the production of the imported merchandise. (iv) Engineering, development, art work, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise. It is alleged by the importer that U.S. design and development expenses incurred in the United States for molds, which are later used in the production of imported merchandise, should not be included in the dutiable value of the imported merchandise. This question was addressed by the Treasury Department in T.D. 81-7 which promulgated the regulations issued under the TAA. Comments received from the public suggested that the definition of "assist" contains the limitation that research and development costs for tools, molds, etc., undertaken in the United States not be dutiable. We stated in response that as this suggestion was contrary to both the Statement of Administrative Action and the Act, we had no authority to adopt it. The position set forth in T. D. 81-7 still represents the position of the Customs Service in this matter. Any discussion of the question presented must be considered in the context of generally accepted accounting principles (GAAP) • Consequently, the rule set forth in the Statement of Administrative Action pertaining to ascertaining the value of the mold takes GAAP into account when it provides: If the assist was acquired by the importer from an unrelated seller, the value of the assist is the cost of acquiring it. The element was produced by the importer or person related to him, its value would be the cost of producing it. If the assist had previously been used by the importer, regardless of whether it had been acquired or produced by such importer, the original cost of acquisition or of production would have to be adjusted downward to reflect its use in order to arrive at the value of the assist…. Thus, when an importer pays an unrelated party to produce a mold its acquisition cost under GAAP would include any research and development that the vendor reflected in its price. This would not only be consistent with GAAP but no authority exists for deducting this amount from the acquisition cost. If the assist was produced by the importer or a party related to it, then under GAAP the cost of producing the assist would include those cost elements necessary to produce it. The following Headquarters rulings expand on these concepts. In TAA Number 12, dated November 25, 1980 (HRL 542146), the importer provided design work to a manufacturer in the United States which produced "bare" circuit boards, then delivered them to the importer. These boards were then shipped with other components to be assembled in Mexico. We held under those facts that the boards were assists as defined in section 402 (h)(1)(A)(ii) of the as materials, components, parts and similar items incorporated in the imported merchandise. The value of the assist was determined to be based upon the price of acquisition since it was acquired by the importer from an unrelated seller (emphasis added). We relied upon the Statement of Administrative Action pertaining to materials, components, parts, and similar items incorporated in the imported merchandise in drawing this conclusion. The cost of acquiring the "bare" circuit boards from the unrelated U.S. seller only included the price paid by the buyer to the manufacturer without the additional cost of the design work since it was the service of manufacturing the "bare" circuit boards which was purchased and not the design work. In TAA Number 55, dated November 29, 1982 (HRL 542948), we held that pursuant to section 152.203(d)(2) , Customs Regulations (19 CFR 152.103 (d)(2)) the U.S. based engineering and development costs incurred by the unrelated seller were not to be excluded from the cost of acquisition of the materials, components, parts. . . incorporated in the imported merchandise. In Headquarters Ruling Letter 544147, dated July 5, 1988, we found that the importer had developed the design work and manufactured the mold from the design work. The value of the assist was determined pursuant to the Statement of Administrative Action regarding tools, dies, molds or other similar items used in the production of imported merchandise which states: "...If the element was produced by the importer or person related to him, its value would be the cost of producing it…” (emphasis added). Included within this cost was the cost of the design work undertaken within the United States. In accord is an example described in T. D. 81-7, a U.S. importer supplied molds free of charge to the foreign shipper. The molds were necessary to manufacture imported merchandise. The U.S. importer had some of the molds manufactured by a U.S. company and others manufactured in a third country. The appraised value included the value of the molds. We held in TAA Number 33, dated June 22 , 1981 (HRL 542324) , that a pattern generator tape to be provided free of charge to a foreign manufacturer for use in fabricating photomasks is in the nature of design work, rather than tooling, and since undertaken in the U.S., is not an assist. T.D. 81-7 also included an example similar to TAA Number 33. In that example, a U.S. importer detailed designs to the foreign producer. These designs were necessary to manufacture the imported merchandise. The U.S. importer bought the designs from an engineering company in the United States for submission to his foreign supplier. The appraised value did not include the value of the design work undertaken in the United States. The assists provided in the United States in TAA Number 12 , TAA Number 55, Headquarters Ruling Letter 544147 and the situations presented fall under section 402 (h)(1)(A)(i) and 402 (h) (1) (h) (i i) of the TAA and are therefore, valued pursuant to their specific provisions in the Statement of Administrative Action. The rules established in T. D. 81-7 pertaining to design and development costs and enforced in the previous rulings are in accordance with "generally accepted accounting principles" as defined in section 402 (g) (3) of the TAA. Therefore, in those cases where a mold is in issue which has been produced by the importer or person related to him, in the United States or a foreign country, its value will be the cost of producing the mold pursuant to the Statement of Administrative Action regarding tools, dies, molds or other similar items used in the production of the imported merchandise. Included in this cost of production are the design and development costs incurred under generally accepted accounting principles when the work at issue is undertaken either within the United States or outside the United States. See, Headquarters Ruling Letter 544347. If the design work is provided by the importer to an unrelated United States manufacturer who constructs the mold, the value of the mold would be based upon the cost of acquisition. This is the price paid by the buyer to the manufacturer without the additional cost of the design work since it is the service of manufacturing the mold which is purchased and not the design work. This would similarly be the outcome if the design work were provided by the importer to the foreign manufacturer who constructs the mold. See, TAA Number 12. Where the unrelated vendor invoices the importer for the designing the mold in the United States and building the mold in its related off-shore facility, the Statement of Administrative Action is again applicable in determining the value of the mold. Again, the value of the assist purchased by the importer from the unrelated seller is the cost of acquiring it. However, the design and development costs would be included in the cost of acquisition under these facts since these costs are paid by the importer. See, TAA Number 55. HOLDING: In view of the foregoing, we conclude that the question of nondutiability of design and development costs will depend on the importer’s cost of acquisition or cost of production, whichever is applicable. In order to determine whether the design and development costs are to be included in the value of the assist, the provision of the Statement of Administrative Action governing section 402 (h)(l)(n)(i) and (ii) are to be applied. Sincerely, John Durant, Director Commercial Rulings Division