Request for Internal Advice on the Dutiability of Certain Salaries, Price Variances and Government Subsidies

May 8, 1991 W544481 VAL CO:R:C:V W544481 pmh CATEGORY: Valuation Regional Director, Regulatory Audit Division Boston, MA RE: Request for Internal Advice on the Dutiability of Certain Salaries, Price Variances and Government Subsidies Dear Sir: This is in response to your memoranda, dated February 13, 1990 and August 28, 1990 (ENT-3-0:RA), regarding a request for internal advice on the dutiability of salaries paid by the importer for engineers provided by the importer to the foreign manufacturer: the dutiability of certain price variances between the standard estimated cost and the actual cost for certain materials provided to the foreign manufacturer by the importer; and the status of subsidies issued to the foreign manufacturer by the government of the country of export. FACTS: According to your memoranda and submissions from counsel for the importer, Ford Electronics & Refrigeration Corporation (FERCO), imports various electronic automotive components from Ford Industria e Commercia Ltda. (FIC), a Brazilian subsidiary of FERCO. The imported merchandise is appraised under computed value. FERCO purchases materials in Japan and resells it to FIC to be used in the manufacture of the electronic components. FERCO sells the materials to FIC at a standard cost based on FERCO’s actual cost at the time of quote plus an inflation factor. This standard cost is established once a year. The Brazilian law requires that prices for imported goods be prearranged with the Brazilian Government. Consequently, the Brazilian License Price of the material is based on FERCO’s standard cost of the materials. Due to fluctuations in the Japanese yen, the actual purchase price of the materials varied. The standard cost at which the goods were resold to FIC was adjusted, subsequently, to reflect FERCO’s actual costs for the material. However, since the Brazilian Government does not allow changes in the prearranged Licensed Price, the transfer price paid by FIC to FERCO did not reflect this adjustment. As a result, the transfer price of the Japanese materials was lower than FERCO’s actual cost. FERCO maintains records of the variances between the Brazilian License Price and the estimated standard cost and of the variance between the actual purchase price for the materials and the standard cost. In addition, FERCO pays part of the salary of 21 employees at FIC. Your office contend that eight of these employees are directly involved (either as engineers or as direct line supervisors) in the production process of the subject merchandise, and that, therefore, the portion of the salaries paid by FERCO is dutiable as a cost of fabrication to be included in the computed value of the subject merchandise. FERCO contends that the duties of these eight employees are supervisory and managerial in nature and, therefore, are not directly related to the production process. FERCO further contends that the salaries of the eight employees do not constitute assists, and as such, are not dutiable. Lastly, FIC receives an export incentive from the Government of Brazil, in the amount of approximately 8% of the sales price for the products sold for exportation. FIC recognizes the incentive in its financial statements and tax returns as a credit to offset the high cost of producing goods in Brazil. FIC does not include the export incentive in the computed value computation for the merchandise it sells to FERCO. Your office contends that the export incentives should be included in the computed value of the merchandise because they cannot be deducted as a cost of materials, fabrication or processing. You further contend that the export incentives should be included as a profit, because the net result of FIC's treatment of the export incentive is a profit being shown on FIC’s books. Additionally, your office recently submitted a letter dated February 14, 1990 from FIC’s Brazilian accounting firm. This letter points out that no accounting presentations have been developed specifically in Brazil to cover this issue. ISSUES: Whether materials purchased by FERCO and resold to FIC at a transfer price that is lower than FERCO’s actual cost for the materials, constitute assists within the meaning of section 402(h)(l)(A). Whether the salaries of certain employees provided to FIC, that are partially paid by FERCO, constitute a cost of fabrication as that term is used in section 402(e)(l)(A). Whether the export incentives provided to FIC by the Brazilian Government should be included in the appraised value computation for the imported merchandise. LAW AND ANALYSIS: We note in reviewing the file that transaction value was rejected as a basis of appraisement because the transfer prices between FIC and FERCO were not sufficient to cover all costs plus a profit. (See page five et al of Audit Report 122-88-FT3-001.) The file is silent as to whether the other opportunities to establish the validity of a related party transaction value have been examined. Nonetheless, under the circumstances presented, we have assumed the merchandise was properly appraised under computed value and offer the following responses to the questions presented. The imported merchandise in this case has been appraised pursuant to computed value, section 402(e) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S. C. (140la). Section 402(e)(l) of the TAA provides that computed value consists of the sum of: the cost or value of the materials and the fabrication and other processing of any kind employed in the production of the imported merchandise; an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind as the imported merchandise that are made by the producers in the country of exportation for export to the United States; any assist, if its value is not included under subparagraph (A) or (B); and the packing costs. With regard to the first issue, we note that section 402(h)(l)(A) of the TAA provides as follows: The term assist means any of the following if supplied directly and free of charge or at a 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 (emphasis added): Materials, components, parts, and similar items incorporated in the imported merchandise. Tools, dies, molds and similar items used in the production of the imported merchandise. Merchandise consumed in the production of the imported merchandise. Engineering, development, artwork, design work, plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise. FERCO contends that because the transfer price for the materials was established according to generally accepted accounting principles and because the variance between the actual cost of the materials and the transfer price charged to FIC resulted from a currency fluctuation, the materials do not constitute an assist. FERCO cites TAA #25, dated May 13, 1981 in support of this contention. In TAA #25, the importer sold components to its overseas plants at standard transfer prices which were based on their estimated costs of making or acquiring the components. Customs held that although the transfer price of the components was based only on estimates of costs plus whatever profit factor the importer included, the transfer prices were in accordance with generally accepted accounting principles and, therefore, acceptable. However, we note that in that case the standard transfer price was adjusted every three months to reflect the fluctuating actual costs of the importer. We also note that TAA #25 is self-limiting. That is, Customs emphasized in that ruling that any determination on the acceptability of a standard transfer price between related parties must be made on a case-by-case basis. Accordingly, Customs later determined that where an importer sold material to its related assembler at a standard transfer price established in accordance with generally accepted accounting principles, such material constituted an assist to the extent the actual cost was reduced. (See TAA #63, dated June 21, 1983 which overrules TAA #58.) In the present case, we find that while the transfer price for the materials sold to FIC was established according to generally accepted accounting principles, an adjustment to the standard transfer price is made once a year, as opposed to every three months as in TAA #25. Furthermore, while the initial transfer price may not have been influenced by the relationship between the parties, the variance between standard and actual costs is easily remedied in this case, due to the fact that records of the variances were maintained by the importer. We believe that under these same circumstances, unrelated parties would make adjustments to their accounts to remedy the variance between standard and actual costs. As noted in TAA #25, these determinations are fact-specific and must be made on a case-by­ case basis. Therefore, based on the principles set forth in TAA #63, we find that the material FERCO sold to FIC to be used in the manufacture of the imported merchandise, constituted an assist to the extent that the standard costs did not reflect the actual costs. With regard to the second issue, you contend that the portion of the salaries of the eight employees provided by FERCO, paid by FERCO is a cost of fabrication, as that term is used in section 402(e)(l)(A) of the TAA. Although FERCO has submitted case precedent addressing whether or not the salaries of the eight employees constitute assists, both you and FERCO agree that the salaries are not assists. Therefore, the only question is whether the portion of the salaries paid by FERCO constitutes a cost of fabrication. The eight employees whose salaries are at issue in this case, are primarily engineering and quality control supervisors who work directly with engineering and production personnel in FIC's Brazil plant. Your office contends that because these employees are so involved with the design and/or design improvement of the imported merchandise, their salaries are a cost of “fabrication ...employed in the production of the imported merchandise.” You cite TAA #44 in support of your position. In TAA #44, dated January 12, 1982, Customs held that plant rental and depreciation costs of a foreign subsidiary that were carried on the accounting books of the U .S. importer, were inherently a cost of fabrication. We do not find that the salaries at issue here are inherently a cost of “fabrication … employed in the production of the merchandise” as were plant rental and depreciation costs. Indeed, as noted above, such costs are not specifically included within the assist definition as set forth in section 402(h)(l). Customs has further held that cost for management supervisory and quality control personnel services are not assists, we do not believe it would be appropriate to treat the salaries of these employees as part of the cost of producing the imported merchandise under section 402(e)(l)(A) as a cost of fabrication. (See TAA #4, dated September 4, 1980; TAA #20, dated March 27, 1983; TAA #46, dated February 22, 1982.) With regard to the last issue, your office argues that the amount of the export incentives should be included in the computed value of the imported merchandise as part of the profit and general expenses under section 402(e)(l)(B) of the TAA. That section of the TAA provides that the computed value of imported merchandise shall include: (B) an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind as the imported merchandise that are made by the producers in the country of exportation for export to the United States. In reference to that provision, section 402(e)(2)(B) of the TAA provides: (B) the amount for profit and general expenses under paragraph (l)(B) shall be based upon the producer’s profits and expenses, unless the producer’s profits and expenses are inconsistent with those usually reflected in sales of merchandise of the same class or kind as the imported merchandise that are made by producers in the country of exportation for export to the United States, in which case the amount under paragraph (l)(B) shall be based on the usual profit and general expenses of such producers in such sales, as determined from sufficient information. As noted above, you contend that the export incentives should be included in the computed value of the imported merchandise pursuant to section 402(e)(l)(B) of the TAA, because its inclusion in FIC’s accounting records results in an overall profit shown. FERCO presently excludes the value of the export incentives from the computed value of the imported merchandise. FERCO contends that this treatment is consistent with section 152.106(b)(l), Customs Regulations (19 CFR 152.106(b)(l)). 19 CFR 152.106(b)(l) and section 402(e)(2)(A) of the TAA provide in pertinent part that the cost or value of the materials and the fabrication and other processing of any kind employed in the production of the imported merchandise “shall not include the amount of any internal tax imposed by the country of exportation that is directly applicable to the materials or their disposition if the tax is remitted or refunded upon the exportation of the merchandise.” However, there is no internal tax involved in this case. FIC is not being refunded an amount for an internal tax it has previously paid. It is receiving a payment from the Brazilian Government to producers of manufactured goods in Brazil. Therefore, section 402(e)(2)(A) of the TAA and 19 CFR 152.106(b)(l) do not apply here. FERCO further contends that the amount of the export incentive should be treated as neither an increase in profit nor a decrease in cost for computed value purposes. In an August 24, 1990 submission, counsel for FERCO argues that computed value appraisements historically have been limited to events which take place up until the time when goods have been fully produced and are packed ready for shipment. Counsel reasons that because the subject incentives do not arise until after the goods are exported they should not be included in the computed value computation. This argument, if carried to its logical conclusion means that if the foreign producer receives payment for his merchandise after exportation of the merchandise, any profit resulting from such payment could never be included in the computed value of the merchandise. This argument is in direct conflict with the intention of sections 402(e)(l)(B) and 402(e)(2)(B) of the TAA. We find that the export incentive should be included in the computed value of the merchandise to the extent that it increases the overall profit and general expenses resulting from the sale of the merchandise. As noted above, section 402(e)(l)(B) of the TAA provides that the computed value of the imported merchandise shall include “an amount for profit and general expenses.” It is our position that profit is the calculated difference between the receipts and the total cost of producing a product and doing business. (See United States v. Alfred Dunhill of London. Inc. , 32 C.A.D. 187 (1945).) Accordingly, the revenue FIC receives from the Brazilian Government upon exporting the subject merchandise is a receipt. As such it should be balanced, along with the sales income received from FERCO, against the general expenses and costs of fabrication of the merchandise. The resulting profit should then be added to the general expenses to arrive at the amount provided for in section 402(e)(l)(B) of the TAA. In this case, the computed value of the imported merchandise is the sum total of this amount and the cost of fabrication as provided for in section 402(e)(l)(A) of the TAA. HOLDING: Under the circumstances set forth above, we conclude that the transfer of materials purchased by FERCO and resold to FIC at a transfer price that is lower than FERCO’s actual cost for the materials, constitute assists within the meaning of section 402(h)(l)(A). The salaries of the eight employees provided by FERCO to FIC, that are partially paid by FERCO do not constitute cost of fabrication as that term is used in section 402(e)(l)(A). The export incentives provided to FIC by the Brazilian Government are included in the computed value of the imported merchandise to the extent that it is reflected in the overall profit and general expenses, pursuant to section 402(e)(l)(B). Sincerely, John Durant, Director Commercial Rulings Division