FOR-2-03-CO:R:C:E 223330 PH
Mr. Loren D. Roth
Senior Vice President-Operations
The Joseph & Feiss Company
Post Office Box 5968
Cleveland, Ohio 44101
RE: Processing of Fabric in Foreign Trade Zone (FTZ); Allowance
for Shrinkage, Defective Fabric, or Scrap Resulting from
Cutting Process; 19 U.S.C. 81c(a)
Dear Mr. Roth:
In your letter of July 15, 1991, you request a ruling on the
dutiability of fabric processed in a foreign trade subzone. You
enclose a number of documents relating to your request. We met
with you on September 24, 1991, and we have communicated with
officials of the Foreign-Trade Zones Board (FTZ Board) about this
matter. Our ruling follows.
In addition to ruling on your request, we are commenting on
an alternative to your proposed operation which we understand the
FTZ Board is considering. Representatives of your company,
representatives of the Office of Textiles and Apparel in the
Department of Commerce ("OTEXA"), staff members of the honorable
Edward F. Feighan, Member of Congress, and representatives from
this office met about this matter on January 27, 1992. At this
meeting, we stated that we would wait for your comments on this
matter for several days before issuing a ruling in response to
your July 15, 1991, ruling request. Since we have not heard from
you about this matter since the January 27 meeting, we are now
issuing the ruling. If you have any further questions about this
matter, please feel free to call on me or Mr. William G. Rosoff,
Chief of the Entry Rulings Branch (202-566-5856), which is the
Branch responsible for the subject of this ruling.
FACTS:
You state that your company has formally applied to the FTZ
Board to be granted foreign trade subzone status. You enclose a
letter in which the OTEXA recommended to the FTZ Board that such
status be granted under certain conditions. The first of these
conditions is that duty for the fabric would be assessed at the
fabric rate and that defects may be dutiable at the appropriate
lower rate of duty. Second, quota and non-quota goods must be
differentiated for entry, quota goods must be accompanied by a
visa, after defects are identified the fabric may be entered into
Customs territory and charged to quota, and duty must be paid on
defects for both non-quota and quota goods. Your company would
then be free to simultaneously cut the quota, non-quota, and
domestic goods outside the subzone or in a deactivated area with
the subzone. Third, your company would have to obtain the
approval of Customs for assessing a lower rate of duty on the
defects which are not physically separated from the fabric before
it is removed from the subzone.
You include a description of the procedures for handling the
fabric and a flow chart demonstrating the procedures. According
to this description, after filing of appropriate documentation
and the initial inspection of the fabric, each bolt or piece of
fabric is uniquely identified and examined and measured.
Damages or defects are marked with stringers in the selvage
(outside edge) of the fabric. If more than 18 damages or defects
are found, the fabric is rejected and scheduled for return to the
foreign manufacturer, never entering Customs territory. Fabric
which is accepted is sent to a storage area.
Before being sent to the storage area, certain fabrics go
through the process of sponging and stabilizing. This process
results in shrinkage, so that the fabric is re-measured and the
new measurements are recorded.
In the storage area the fabric is stored in bins and is
controlled by a computer record-keeping process. All of the
information required by 19 CFR 146.23 is contained in these
records.
Pieces of fabric remain in the storage area until they are
needed for production. When cutting documents are created,
notification is sent to the storage area to pull the fabric to be
used for the particular cutting. When the fabric is pulled,
personnel in the storage area note the quantity of defects in the
fabric and then add additional fabric to cover loss due to the
defects. Based on experience, your company allows 1 additional
increment of fabric for 1 to 6 defects, 2 additional increments
for 7 to 12 defects, and 3 additional increments for 13 to 18
defects. An additional yard of fabric is allowed for each "bar"
defect (i.e., damage running the width of the fabric).
Under your proposal, after the necessary yardage has been
pulled in the storage area, the appropriate duty would be
assessed. It is proposed that this duty would be calculated on
the total quantity of yardage pulled, less the defective yardage.
After calculation of the duty due, the yardage would be removed
from the subzone and, only then, would the actual cutting take
place. After cutting, all damaged pieces would be re-cut and the
damaged pieces would be destroyed.
Some of the fabric which is sent to the storage area would
be sold to other manufacturers rather than being used by your
company in the production of garments. Such fabric which is
resold to other manufacturers outside the United States would be
exported and would not enter the Customs territory. Such fabric
which is resold to domestic manufacturers would be assessed duty
based on the total yardage shipped, without any adjustments for
damages. This is so, you state, because these fabrics are sold
on an "as is" basis.
For purposes of this ruling, we assume that the fabric under
consideration is dutiable on the basis of its value (i.e., not on
the basis of its quantity). This is indicated to be the case in
the schematic of procedures referred to in the July 1, 1991,
letter from the Deputy Assistant Director, OTEXA, to the
Executive Secretary, FTZ Board, a copy of which you provided us.
ISSUES:
(1) Upon removal of fabric from a foreign trade subzone
into the Customs territory, may allowance be granted for
shrinkage of the fabric effected by a shrinking process in the
subzone?
(2) Upon removal of fabric from a foreign trade subzone
into the Customs territory, may allowance be granted for defects
in the fabric when the defects are found by examination in the
subzone and are marked in the subzone but the defects are not cut
out of the fabric until after it is removed from the subzone into
the Customs territory?
LAW AND ANALYSIS:
It is a basic concept of Customs law that articles which are
imported into the United States are classified and duty is
assessed on the basis of their condition when they are imported
into the United States, not on the basis of what their condition
may become after being imported into the United States (United
States v. Citroen, 223 U.S. 407, 414-415 (1911), and cases cited
therein; see also Simod America Corp. v. United States, 872 F. 2d
1572, 1577 (Fed. Cir. 1989)). An exception to this general rule
is the Foreign Trade Zone Act of June 18, 1934, as amended (19
U.S.C. 81a et seq.) (see 19 CFR Part 146 for the Customs
Regulations pertaining to foreign trade zones (FTZ's)). Under
section 3(a) of this Act (19 U.S.C. 81c(a)), merchandise may be
brought into a FTZ and its classification and dutiability may be
delayed until it, or merchandise resulting from its manufacture
or manipulation, is brought into the Customs territory of the
United States. Such merchandise is called non-privileged foreign
status merchandise.
In the first proviso of section 3(a) of the FTZ Act, the FTZ
Act also provides for the privilege of having merchandise brought
into a FTZ classified and duties and taxes thereon calculated at
any time before the merchandise is manipulated or manufactured,
if such a privilege is requested. Such merchandise is called
privileged foreign status merchandise. The legislative history
to this provision, as well as the clear wording of the statute,
make it very clear that the appraisement, classification, and
liquidation of duties on foreign merchandise when privileged
foreign status is granted are final and, "once made, would
thereafter govern the dutiable and taxable status of the
merchandise whenever it was sent into customs territory, whether
or not it had been manipulated or manufactured in the zone in the
meantime" (see Sen. Report 1107, 81st Cong., 1st Sess. (1949)
(printed at 1950 U.S. Code Cong. Serv. 2533, see pp. 2535-2536)).
Also under this proviso, allowance is to be made for recoverable
or irrecoverable waste resulting from the manufacture or
manipulation of privileged foreign status merchandise in a FTZ.
If such recoverable waste is sent into the Customs territory it
is classifiable and dutiable in its condition, quantity, and
weight at the time of entry.
The Customs Regulations concerning FTZ's are found in 19 CFR
Part 146. The regulations concerning the classification,
valuation, and liquidation of merchandise transferred from a FTZ
into the Customs territory are contained in 19 CFR 146.65. This
section provides that privileged foreign status merchandise is
subject to tariff classification according to its character,
condition and quantity, at the rate of duty and tax in force on
the date of filing, in complete and proper form, the application
for privileged status. Non-privileged foreign status merchandise
is subject to tariff classification in accordance with its
character, condition and quantity as constructively transferred
to the Customs territory at the time the entry or entry summary
is filed. The dutiable value of privileged or non-privileged
foreign status merchandise is the price actually paid or payable
for the merchandise in the transaction that caused the
merchandise to be admitted into the FTZ, plus certain additions
and less certain subtractions, and if there is no such price the
dutiable value is based on an alternative determination provided
for in section 146.65 (see recent amendments to 19 CFR
146.65(b)(2), effected by Treasury Decision 91-79).
In this case, the fabric is sent from the subzone into the
Customs territory after it is shrunk (if it is subject to the
sponging and stabilizing process) but before any waste is cut
out. As such, it consists of a piece of fabric which, although
it may be marked to indicate defects, is still fabric with
defects. Only after the fabric is cut, is there both fabric and
scrap or defective fabric. Since the cutting takes place after
the fabric leaves the subzone, allowance for defects may not be
granted under the statute. Neither may any allowance for
shrinkage be allowed, because the dutiable value of the
merchandise would be based on the price paid or payable for the
merchandise in the transaction that caused the merchandise to be
admitted into the FTZ, with certain adjustments not pertinent to
this discussion (see 19 CFR 146.65(b)(2)). (Note, that the
merchandise under consideration is dutiable on the basis of its
value (ad valorem).)
For your information, General Note 5 of the Harmonized
Tariff Schedule of the United States Annotated (HTSUSA) has no
application in this case. That provision provides that when
goods subject to different rates of duty are packed together or
mingled so that the quantity or value of each class of goods
cannot be readily ascertained by Customs, the goods shall be
subject to the higher rate of duty unless, in addition to certain
other conditions, the consignee segregates the goods within a
provided period of time under Customs supervision. In this case,
when the fabric leaves the subzone it is not two classes of goods
commingled, it is, as stated above, only one class of goods,
i.e., fabric. Only after defects are cut out may there be two
classes of goods.
As stated above, we understand that the FTZ Board is
considering an alternative to the operation you describe in your
ruling request. Under this alternative operation, fabric would
be cut in the FTZ and defective and non-defective fabric would be
segregated in the FTZ. The fabric would be subject to quota and
visa requirements at the time of admission to the FTZ.
Privileged foreign status would be required to be elected on all
fabric admitted into the FTZ. Duties would be based on the full
value of the fabric in the condition and quantity at the time of
admission to the FTZ, except for the material that is found to be
defective (we understand that defective pieces or panels of
fabric would also be removed from the FTZ as "seconds"). Waste
resulting from the cutting process ("cutting room scrap") would
be determined to have no value based on application information
and would be destroyed in the FTZ with the allowance reflecting
this determination.
Our comments on the foregoing proposal follow. We
understand that OTEXA may grant its approval to the operation,
provided that privileged foreign status is elected at the time of
admission of the fabric to the FTZ and the fabric is subject to
quota and visa requirements as of the time of admission to the
FTZ. Assuming that this is so, we would not object to this part
of the alternative operation. Of course, election of privileged
foreign status would result in the dutiability of the merchandise
removed from the FTZ being based on its condition at the time of
election of privileged foreign status. Defective fabric cut and
segregated in the FTZ from non-defective fabric and removed from
the FTZ as "seconds" would not be subject to any allowance and
would be dutiable on the basis of its condition at the time of
election of privileged foreign status because such "seconds" are
expressly excluded from the category of textile waste by the
Explanatory Notes to the Harmonized Tariff Schedule of the United
States (19 U.S.C. 1202), heading 6310. Although "cutting room
scrap" resulting from the cutting of non-defective fabric may
qualify for the allowance provided for in the FTZ Act, we
understand that OTEXA is opposed to the granting of any such
allowance.
HOLDINGS:
(1) Upon removal of fabric from a foreign trade subzone
into the Customs territory, allowance may not be granted for
shrinkage of the fabric effected by a shrinking process in the
subzone.
(2) Upon removal of fabric from a foreign trade subzone
into the Customs territory, allowance may not be granted for
defects in the fabric when the defects are found by examination
in the subzone and are marked in the subzone but the defects are
not cut out of the fabric until after it is removed from the
subzone into the Customs territory.
Sincerely,
John Durant, Director
Commercial Rulings Division