Application for Further Review of Protest No. 3701-90-0001; Price Actually Paid or Payable

HQ W544609 August 12, 1991 VAL CO:R:C:V W544609 pmh CATEGORY: Valuation District Director of Customs Milwaukee, WI 53110 RE: Application for Further Review of Protest No. 3701-90-0001; Price Actually Paid or Payable Dear Sir: The above referenced protest application for further review is against your decision regarding the dutiability of certain payments for the design and development of a prototype for an MVP X-ray generator. FACTS: According to your May 7, 1990 memorandum submitted with the Customs Protest and Summons Report, General Electric Medical Systems Group (hereinafter referred to as “GEMS”) produces and imports diagnostic medical imaging equipment. In 1985 and 1986 GEMS paid $943,691.00 to General Electric Electromedicina, S.A. (hereinafter referred to as “GEMED”), for the design and development of an LCX generator. A prototype in 1985 and a second prototype in 1986 were built for testing. According to a November 27, 1989 memorandum from counsel for GEMS, GEMED sold a test unit to GEMS for clinical evaluation in 1986. Based upon favorable results, the generator was redesignated “MVP X-ray generator,” and seven production units were subsequently sold to GEMS and imported in 1986. In 1987, 302 units were imported and in 1988, 362 units were imported. The import specialist determined that the $943,691.00 in research and development costs was necessary for the production of the imported merchandise and that, therefore, it constituted an assist. Counsel for the importer contended that the $943,691.00 was paid to GEMED's engineering department for research and development costs “to develop the specification and performance parameters” of a low-cost generator. Counsel maintains that such specifications and parameters were not necessary for the production of the imported merchandise and that therefore, the payment is not dutiable. In addition, counsel argued that the payment is not dutiable because: (1) it was for research and design costs incurred prior to the actual production of the merchandise; (2) the product of the research and design was intangibles in the form of writings, drawings and recordings and, therefore, exempt from duty under General Headnote 5(e) of the Harmonized Tariff Schedule of the United States (HTSUS); and (3) the total $943,691.00 was for the development of the first prototype, which was never imported. Lastly, counsel argued that if the $943,691.00 in research and design costs is determined to be dutiable, then it should be apportioned over the entire amount of units produced. ISSUE: Whether $943,691.00 GEMS paid to GEMED for research and development of two prototypes is part of the price actually paid or payable for the subsequently imported merchandise. LAW AND ANALYSIS: The preferred method 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). As you know, section 402(b)(1) of the TAA provides, in pertinent part, that the transaction value of the imported merchandise is the “price actually paid or payable for the merchandise when sold for exportation to the United States” plus enumerated additions. One such addition is the value, apportioned as appropriate, of any assist. The term “price actually paid or payable” is defined in section 402(b)(4)(A) of the TAA as “the total payment (whether direct or indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of merchandise …) made, or to be made, for the imported merchandise by the buyer to, or for the benefit of, the seller.” Your office contends that the $943,691.00 GEM paid to GEMED for research and development of the LCX generator, constitutes an assist necessary to produce the imported article. We note that section 402(h)(1)(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: Materials, components, parts, and items incorporated in the imported merchandise. (ii) Tools, dies, molds similar items used in the production of imported merchandise. (iii) Merchandise consumed in the production of the imported merchandise. (iv) Engineering, development, art work, design work, plans and sketches that are undertaken elsewhere in the United States and are necessary for the production of the imported merchandise. A payment of money from the buyer to the foreign manufacturer does not constitute an assist within section 402(h)(1)(A). However, Customs has held that payments made to the seller/manufacturer for expenses incurred for design and development are part of the price actually paid or payable for the imported merchandise, if such design and development is necessary to produce the subject merchandise. (See HRL 543324, dated August 8, 1984 and HRL 543983, dated December 2, 1987.) Therefore, the question in this case becomes whether the prototypes that were paid for with the $943,691, were a necessary step in the production of the ultimately imported generators. As noted above, counsel contends that the prototypes were prior to the actual production of the merchandise and were merely “conceptual” in nature, i.e., to establish specification and performance parameters. Therefore, counsel reasons that they could not be used in the production of the imported merchandise. In support of this contention, counsel has submitted the initial drawings by the engineering department, and notes that the drawings by the manufacturing department were of more precise detail. In addition, counsel has provided a copy of software specifications for the LCX console, provided by the engineering department. He notes that these specifications indicate only the parameters of the intended operation of the console and do not describe the manner in which the console should be manufactured. With regard to the above-noted submissions, we find that the subsequent drawings (by the engineering department included in the $943,691.00 cost, and by the manufacturing department) are more mechanically precise and, in some instances, include an additional component(s). However, we do not agree with counsel that this means the initial drawings were not necessary to production. We note that the standard set forth in our earlier rulings and noted above, is whether the engineering is “necessary” for production, not “used” in production. While the later drawings may have provided the blueprints actually “used” in the production of the article, the engineering that produced the initial layout for those blueprints was “necessary” for the production of the imported article. The fact that the initial drawings were refined by the manufacturing department does not make the initial engineering required for the project, any less necessary a step in producing the ultimate article. We note that counsel has cited HRL 543417, dated February 11, 1985, in support of his argument. In that ruling Customs held that initial sketches of knives, kettles and flatware were not necessary to the production of the finished article. However, in that case, the subject article was considerably less sophisticated than the subject generators in this case. That is, all plates are basically alike, of the same design. Consequently, the drawing of a basic plate offers no assistance to the overall production of the plate; it is the later design or artwork that distinguishes the plate from all other plates. In this case, the subject merchandise is quite different. All generators are not alike. Consequently, the initial design work is much more significant to an article like a generator than it is to a plate. We also point out, that in HRL 543417, we stressed that there are no hard and fast rules with regard to the status of engineering work and that these determinations should be made on a case-by-case basis. Therefore, in TAA #13, dated December 4, 1980, for example, Customs held that drawings and a “crude working model” of a product is necessary to the production of the imported product and would be dutiable if such items were developed outside the United States. With regard to the software specifications prepared by the engineering department, we agree that these are probably not necessary to the production of the imported merchandise. However, without a breakdown of cost, we cannot determine what portion of the $943,691.00 payment was for that part of the project and what portion was for the dutiable development of drawings and prototypes. Without such a breakdown, we must necessarily find the total payment dutiable. Finally, we note counsel's additional arguments that the subject payment should not be dutiable because it is for research and development prior to production of the imported merchandise and that since the payment was for the development of the prototype, it should be applied solely to the prototype, itself. Customs has long held that research and development and payments made for the same, prior to the actual production of the imported merchandise is dutiable as either an assist or as part of the price actually paid or payable for the merchandise, if such research and development is necessary to the production of the merchandise. (See TAA #13, dated December 4, 1980; TAA #33, dated June 22, 1981; HRL 543324, dated August 8, 1984; HRL 543376, dated November 13, 1984.) Counsel cites our HRL 543412, dated April 3, 1985, in support of his argument that payment for the development of the prototypes should be applied solely to the prototypes. However, while Customs did hold in that ruling that payments for the development of a prototype should be applied to the value of the prototype, that holding was based on the fact that the prototype, itself, had been imported as a separate article of commerce. Therefore, Customs reasoned that the payment for research and development had been dutied at the time the prototype had been imported. Such reasoning does not apply in the case at hand, because the prototypes were never imported. The facts of this case are similar to those in HRL 543376, dated November 13, 1984, in which Customs held that payments made to the foreign seller by the buyer for the development of a prototype, were part of the price actually paid or payable for the imported merchandise. Lastly, counsel argues that in the event we should determine that the $943,691.00 is dutiable, it should be apportioned over the total number of units produced world-wide. However, we note that counsel did not submit any documentation whatsoever as to whether units are sold anywhere other than the United States or as to the total number of units produced world­wide. Consequently, the appraising officer appropriately assigned the value of the payment to a single entry of the imported merchandise. HOLDING: The $943,691.00 payment from GEMS to GEMED for research and development of a prototype X-ray generator, is part of the price actually paid or payable for the imported merchandise. Accordingly, you are directed to deny this protest. A copy of this decision should be attached to the Form 19, Notice of Action, to be sent the protestant. Sincerely, John Durant, Director Commercial Rulings Division