DRA-1-06/2-01-CO:R:C:E 224295 PH
Regional Commissioner of Customs
North Central Region
55 East Monroe Street
Chicago, Illinois 60603-5790
ATTN: Chief Region Drawback Branch
RE: Protest 3901-92-100583; Substitution Manufacturing Drawback;
Customs Audit; Random Sample; Statistical Analysis
Dear Sir:
The above-referenced protest was forwarded to this office
for further review. We have considered the points raised by your
office, the protestant, and the materials in the file. Our
decision follows.
FACTS:
The protest is of the liquidation of 57 drawback entries (or
claims) dated August 7, 1986, through October 26, 1989. The
protestant had received $807,260 in accelerated payments of
drawback for the entries under protest. The entries were the
subject of a Customs audit (Report Control No. 321-89-DRO-006,
dated August 6, 1991). During the course of the audit, personnel
of the protestant met with Customs officials. The protestant
submitted amended entries (of the 57 drawback entries under
consideration) on May 15, 1990, August 27, 1990, and December 4,
1990. The protestant conceded a number of errors in its original
entries and returned $203,294 (received by Customs on October 1,
1990) of the $807,260 in accelerated payments.
Using established statistical analysis procedures, (i.e.,
establishing the applicable universe, determining the acceptable
rate of error, and using the appropriate tables for sampling size
and random selection of samples), a randomly selected sample of
the designated imported parts upon which drawback was claimed in
the 57 entries under consideration was selected. This sample
selection was applied to the second amendment (that submitted on
August 27, 1990) because, according to the audit report, the
sample had already been agreed upon when the third amendment was
filed. According to the Customs Regional office which performed
the audit, a list of the 291 parts selected to be sampled was
provided to the protestant and the protestant agreed and approved
the selected parts on November 20, 1990. The protestant also
states that it agreed to the sample (although after the
protestant reviewed the final results it contended that the
sample was distorted).
The above sampling procedures resulted in the audit of a
sample of 291 parts out of a universe of 6,580 parts in the
entries under consideration. Of the 291 parts sampled,
deficiencies were found with regard to 120 parts. The total duty
refunded as drawback for the 291 sampled parts was $40,371
($138.732 per part). The total duty refund which the audit
report stated should have been disallowed was $18,442 ($63.375
per part). This disallowance per part was projected to the total
universe of parts, resulting in a calculation that $412,837
should be disallowed (i.e., $63.375 X 6,580 parts = $417,007 X
99% = $412,837).
The entries were liquidated in accordance with the above
advice between December 20, 1991, and February 7, 1992. The
liquidations of the entries were protested on March 17, 1992. In
addition to contending that the sample selected for audit
distorted the error rate for the entries, the protestant
specifically discussed certain items cited in the audit report.
These issues are analyzed in the LAW AND ANALYSIS portion of this
ruling.
ISSUE:
Is there authority to grant the protest of the denial of
drawback described in the FACTS portion of this ruling?
LAW AND ANALYSIS:
Initially, we note that the protest, with application for
further review, was timely filed under the statutory and
regulatory provisions for protests (see 19 U.S.C. 1514 and 19 CFR
Part 174). We note that the refusal to pay a claim for drawback
is a protestable issue (see 19 U.S.C. 1514(a)(6)).
The drawback entries which are protested are for drawback
under 19 U.S.C. 1313(b). Basically, section 1313(b), often
called the substitution manufacturing drawback law, provides that
if imported duty-paid merchandise and duty-free or domestic mer-
chandise of the same kind and quality are used in the manufacture
or production of articles within three years of the receipt of
the imported merchandise by the manufacturer or producer of the
articles and articles manufactured or produced from the imported
duty-paid merchandise or duty-free or domestic merchandise are
exported or destroyed within five years of the importation of the
duty-paid merchandise, 99 percent of the duties on the imported duty-paid merchandise shall be refunded as drawback,
even if none of the imported merchandise was actually used in the
manufacture or production of the exported articles. The Customs
Regulations pertaining to drawback are found in 19 CFR Part 191.
The protestant claimed drawback under the general drawback rate
for articles manufactured with the use of component parts
(published in Treasury Decision (T.D.) 81-300).
The specific findings in the audit report addressed in the
protest are discussed below.
On page 7 [page references are to the audit report],
paragraph a) [at top of page], the report states that
quantities of the designated imports were greater than the
quantities actually imported. The protestant concedes this
error.
On page 7, paragraph b), the report states that a non-
existent consumption entry was used to designate imported
merchandise. The protestant appears to concede this error
(i.e., the error is addressed in the "corrections" section
of the protest and is stated to represent a misreading of
the consumption entry number). The protest is DENIED in
this regard.
On page 7, paragraph c), the report states that the duty
claimed per part was greater than the duty actually paid.
The protestant concedes this error.
On page 7, paragraph d), the report states that the imports
designated were duty-free merchandise, although drawback was
claimed. The protestant concedes this error.
On page 7, paragraph e), the report states that the
protestant was unable to relate Certificates of Delivery
against vendors' invoices and inventory records. The
protestant attempts to explain this deficiency by stating
that import vendors supplied the protestant with
certificates of delivery showing delivered quantities which
often would not match quantities received by the protestant.
In this regard, we note that the Customs Regulations require
that a Certificate of Delivery in this situation "must
describe the merchandise delivered, tracing it from the
custody of the importer to the custody of the manufacturer"
(19 CFR 191.65(a)). The protest is DENIED in this regard.
On page 7, paragraph f), the report states that the
protestant did not provide records for a number of specified
reasons. The protestant contends that this statement is not
supported in the audit report by specific references and
should be ignored. The material which we have available to
us in the file does not indicate which parts sampled have
this deficiency. To the extent that drawback is denied on
this ground without reference to a specific sampled part and
specific records, the protest is GRANTED in this regard
(otherwise, the protestant is denied the right of protest
for that item). However, if drawback is denied on this
ground with regard to a specific sampled part and specific
records, the protest is DENIED in this regard for the
following reasons. The Customs Regulations (19 CFR 191.32,
191.2(o), 191.5, 191.10) require the keeping of certain
records for drawback and that the records be available for
examination by Customs. In its drawback contract, the
protestant agreed to maintain certain described records and
to make the records available for audit by Customs. The
protestant stated it understood that "drawback is not
payable without proof of compliance" and that "if [its]
records do not show that [it] satisf[ies] those legal
requirements [relating in part to record-keeping], drawback
cannot be paid."
On page 7, paragraph a) [bottom of page], the report states
that certain designated imports were not used in production
and were in inventory. The protestant concedes that its
records did not correctly show the parts going into the
factory but states it could not build the articles without
this "single-sourced" part. Therefore, the protestant
contends, this error really had no effect on drawback. The
protestant also appears to contend that it could have
established compliance with this requirement (i.e., timely
use of the imported designated merchandise) by use of a
first-in, first-out (FIFO) accounting method. With regard
to the lack of proper records, see discussion of record-
keeping requirements, above. In the drawback contract
signed by the protestant, the protestant specifically agreed
to keep records to establish compliance with this
requirement. As to the protestant's arguments on the use of
the FIFO accounting method to establish the timely use of
the imported designated merchandise, it is true that "if
FIFO accounting records are used and these records prove use
for drawback purposes, these records can be the basis for
allowance of drawback" (C.S.D. 79-301). However, there is
no evidence in the file to show that the conditions
precedent for use of the FIFO accounting method in the above
quotation are met. The protest is DENIED in regard to this
issue.
On page 8, paragraph b) [top of page], the report states
that designated imported parts were identified on the
drawback claims as two different part numbers, although they
were one and the same part, resulting in the protestant
claiming drawback twice on the same designated imports. The
report refers to Exhibit 2 in this regard. The protestant
does not comment on this item. The parts referred to in
Exhibit 2 were not, themselves, part of the statistical
sample, although the Exhibit does illustrate unrebutted (by
the claimant) deficiencies in the claims. Because this
ruling is based on the sampled parts, the deficiencies shown
by Exhibit 2 do not affect the protest decision.
On page 8, paragraph c) [top of page], the report states
that designated imported parts were rejected as not meeting
the protestant's quality control standards. The protestant
states that it was having a problem with a supplier and
there was a lot of movement in and out of the factory with
this part. The protestant states that this "single-sourced"
part was necessary for the manufactured article and,
therefore, this error really had no effect on drawback. See
discussion of paragraph a), page 7 [bottom of page], in this
regard. The protest is DENIED, on the same basis, in regard
to this issue.
On page 8, paragraph d), the report states that the
protestant was unable to relate Certificates of Delivery
against vendors' and certain worksheets and reports. See,
in this regard, discussion of paragraph e), page 7. The
protest is DENIED, on the same basis, in regard to this
issue.
On page 8, paragraph e), the report states that the
protestant did not provide records for a number of specified
reasons. See, in this regard, discussion of paragraph f),
page 7. On the same basis, to the extent that drawback is
denied on this ground without reference to a specific
sampled part and specific records, the protest is GRANTED in
this regard and, if drawback is denied on this ground with
regard to a specific sampled part and specific records, the
protest is DENIED in this regard.
On page 8, paragraph a), the report states that designated
imported parts claimed were never used to produce the
exported model (citing Exhibit 3). The protestant does not
directly address this item, but questions the apparent
indication by the report that designated imported parts must
be used to produce the exported model (in drawback under 19
U.S.C. 1313(b), of course, although the designated imported
merchandise and the substituted duty-free or domestic
merchandise must be used in a manufacture or production,
either or any combination of both may be used in the
manufacture or production of the exported article). We
conferred with the appropriate local Customs official in
this regard and found that the deficiency in this item is
that no part of the same kind and quality as the designated
imported part appeared in the exported article. We note
that each of the parts listed in Exhibit 3 is one of the
parts selected in the sample for audit. The protest is
DENIED in this regard.
On page 8, paragraph b) [bottom of page], the report states
that discontinued, obsolete and cancelled designated imports
were claimed to have been used to produce the exported
models (citing Exhibit 4). See, in this regard, discussion
of paragraph b, page 8 [bottom of page]. The protest is
DENIED, on the same basis, in regard to this issue.
On page 8, paragraph c) [bottom of page], the report states
that quantities of parts claimed on drawback entries
exceeded the "bill of materials quantities" (citing Exhibit
5; this exhibit clarifies this item, describing the
deficiency to be one in which the quantity of parts actually
appearing in the manufactured article, according to the bill
of materials, is less than the quantity of the same parts
claimed to appear in the manufactured article). The
protestant contends that this statement is not supported in
the audit report by specific references and should be
ignored. As explained above, this item does appear to be
supported in the audit report by specific references (see
Exhibit 5); clearly an overpayment of drawback results if
more parts are claimed for drawback than appear in the
manufactured article which is exported. Each of the parts
listed in Exhibit 5 appears to be one of the parts selected
in the sample for audit, with the possible exception of part
AT 38206. The protest is DENIED in this regard, except with
regard to part AT 38206 (if it is not one of the parts
selected in the sample for audit, in which case the protest
is GRANTED in this regard, for this part).
On page 9, paragraph a), the report states that quantities
of models claimed on the drawback entries to have been
exported exceeded the quantities of models actually shipped
and exported per the exportation records examined (citing
Exhibit 6). The protestant does not comment on this item.
A drawback claimant is specifically required to establish
exportation of articles for drawback purposes by the Customs
Regulations (19 CFR 191.51 et seq.) In the drawback
contract signed by the protestant, the protestant
specifically stated that it understood that "it must be
established that the completed articles were exported within
5 years after the importation of the imported merchandise."
The protest is DENIED in this regard.
On page 9, paragraph b), the report states that exported
models on which drawback was claimed were shipped to Puerto
Rico and, therefore, drawback should not have been allowed
on those models. The protestant concedes this error.
On page 9, paragraph c), the report states that certain
exports were claimed, for drawback purposes, more than once
(citing Exhibits 6 and 7). The protestant does not comment
on this item. See discussion of paragraph a), page 9, in
this regard. The protest is DENIED in this regard.
On page 9, paragraph d), the report states that the
protestant was unable to provide exportation records on
shipments between November 1, 1983, and April 28, 1987. The
protestant contends that it could have provided records
(i.e., invoice records invoicing a foreign location and a
payment record for the same), but it was unable to provide
records in the format requested by Customs. The protestant
contends that such records should be satisfactory. As
stated in our comments on paragraph a), page 9, the Customs
Regulations have specific requirements for the establishment
of exportation for drawback purposes and the protestant
agreed to establish exportation in its drawback contract.
The cited Customs Regulations provide several alternative
kinds of evidence to establish exportation. Unless the
protestant meets one of these alternative requirements, the
protest is DENIED in this regard.
In addition to the specific items in the audit report
discussed above, the protestant comments on certain more general
items in the audit report (see pages 5 and 6 of the report).
These more general items do not appear to have had any effect on
the specific recommendations made in the audit report (i.e., the
conclusion of the audit report is that there should be a
disallowance of drawback for: (1) "receipt and used-in production
of the designated imports"; (2) "used-in production of the
designated imports to produce the exports" [as noted in the
discussion of paragraph a), page 8, this deficiency is actually
that no part of the same kind and quality as the designated
imported part appeared in the exported article]; and (3)
"shipment of exports"; and these three groups are dealt with in
the specific items discussed above). Therefore, we are not
commenting on the more general items, except insofar as our
comments on the specific items relate to them.
The protestant also contends that the statistical sample
used in this case highly distorted the error rate applied to the
drawback entries. In support of this contention, the protestant
notes that the average drawback claimed for the sampled parts was
$138.73 although the average drawback claim for the universe of
6,590 parts was $92.91. The protestant states that it understood
the purpose of the use of the statistical sample in this case to
be to determine a mean rate of error, with a maximum tolerable
rate of error of 10%. Noting that the difference in claimed
drawback in the sampled parts and in the entire universe is
$45.82 per part, or 49.3%, the protestant contends that this
illustrates the distortion in the sample.
The Courts have approved the use of statistical analysis in
various situations (see, e.g., Castaneda v. Partida, 430 U.S.
482, 97 S.Ct. 1272 (1977), and cases cited therein; see also
Texpor Traders, Inc. v. Trust Co. Bank, 720 F. Supp. 1100 (S.D.
N.Y. 1989), in which the Court took judicial notice, "that in
statistical analysis, using a well known mathematical theorem,
viz, the Central Limit Theorem, a sample size of thirty or more
is generally recognized as sufficient to guarantee normality of
the distribution of sample means" (Note 2, 720 F. Supp. at 1105);
and Bright, Kadane, and Nagin, Statistical Sampling in Tax
Audits, 13 JOURNAL OF THE AMERICAN BAR FOUNDATION, Law & Social
Inquiry 305 (1988), see in particular pp. 310-318).
We also note that the Congressional Committees with
oversight of the drawback laws have recognized the validity of
the use of sampling as a drawback audit technique. Public Law
103-182, the "North American Free Trade Agreement Implementation
Act", has been enacted by both Houses of Congress and was signed
into law by the President on December 8, 1993. Section 632 of
Public Law 103-182 contains a number of amendments to the
drawback law (19 U.S.C. 1313). In the House and Senate reports
on H.R. 3450, the bill which was enacted as Public Law 103-182,
it was stated in regard to drawback that:
... [T]he Committee expects that, if the entire universe of
the claimed import entries and exports is audited, and the
audit reveals that only a portion of a company's claims are
deficient, drawback should be denied only on that portion
found to be deficient. However, if only a representative
sample of the claimed import entries and exports is audited,
and the audit reveals that a significant portion of the
audited claims is deficient, then denial of the audited
company's drawback claims may extend beyond the portion
audited. [H. Report 103-361, 103d Cong., 1st Sess., 132
(1993); see also, S. Report 103-189, 103d Cong., 1st Sess.,
84 (1993), which contains similar language.]
In this case the sample was selected using established
statistical analysis procedures (the applicable universe was
established, an acceptable rate of error was determined, and the
appropriate tables for sampling size and random selection of
samples were used). After selection of the parts to be audited
in the sample, the protestant was given a list of the selected
parts and approved the sample selected. To this point in the
process, we see no inconsistency with the above authorities in
the sampling process.
However, according to both the protestant and the audit
report, "a maximum tolerable rate of error of 10%" was agreed
upon. According to the calculations in the audit report, the
rate of error was more than 67% (of the $611,369 stated to be
included in the amended claim, $412,832 was disallowed), far in
excess of the agreed upon maximum tolerable rate of error. (Even
with the correction to the calculations in the audit report
discussed below, the rate of error was much more than that which
was agreed to be acceptable.)
Upon finding an unacceptable rate of error, Customs should
have either given the claimant an opportunity to correct its
claims and re-audited the corrected claims with the use of an
agreed-upon sample or performed a 100% audit (i.e., without
recourse to statistical sampling) and liquidated the claims
accordingly. Instead, Customs proceeded to liquidate the claims,
projecting the rate of error it calculated from the audit to the
entire universe of drawback claimed in the entries.
Once liquidated, a liquidation may not be "unliquidated"
(see United States v. Utex International Inc., 6 Fed. Cir. (T)
166, 857 F. 2d 1408 (1988)). Absent probable cause to believe
there is fraud (see 19 U.S.C. 1521), the only action Customs is
authorized to take on a liquidation which has been timely
protested and for which the 90 days for voluntary reliquidation
have elapsed (see 19 U.S.C. 1501) is to allow or deny the protest
in whole or in part (see 19 U.S.C. 1515(a) (in this regard, see
also 19 U.S.C. 1515(c) and (d), as added to section 1515 by
section 617 of Public Law 103-182)).
Therefore, we must consider this protest as presented (i.e.,
even though Customs liquidated the entries on the basis of rates
of error which were agreed upon by Customs and the protestant to
be unacceptable). We conclude that the audit report erroneously
projected the audit findings to the universe of drawback claimed
in the entries. As stated above, 291 parts were sampled and 120
of those parts were found to have deficiencies. Thus, the simple
rate of error was 41.24%. The total drawback claimed for the 291
parts sampled was $40,371 and the total drawback disallowed was
$18,442. Thus, the rate of error based on drawback claimed for
the sampled parts was 45.68% As stated above, either of these
rates of error were agreed upon in advance to be unacceptable.
The audit report compounded the error of using an
unacceptable rate of error by its calculations to determine the
drawback which should be disallowed. This was done by using a
multiple-step process (which decreases the level of reliability)
in which the total drawback disallowed on the sampled parts
($18,442) was divided by the parts sampled (291) and the result
($63.375) was projected to the total parts in the universe. As
stated above, this results in an effective error rate of in
excess of 67% (of the $611,369 stated to be included in the
amended claim, $412,832 was disallowed). The fallacy in the
method used in the audit report is illustrated by projecting the
total drawback (allowed and disallowed) per sample audited to the
entire universe (i.e., $138.55 X 6580 = $948,999). This is
approximately 55% more than the actual entire universe (stated to
be $611,369).
We understand that the purpose of the projection method used
in this case may have been to take into consideration the great
variances in drawback per part. Such a concern is proper, but
should be acted upon in the selection of the sample (e.g., by
stratified sampling) (see, generally, in this regard the article
by Bright, Kadane, and Nagin, cited above). As stated above,
attempting to redress this concern in the projection of the rate
of error, as was done in the audit report, decreases the level of
reliability of the sample. We conclude that in this case, in
which a simple random sampling method was used, the disallowance
of drawback from the sample audited should have been projected on
the basis of the simple rate of error (41.24%). The protest is
GRANTED, in part, in this regard.
According to the audit report, the amount of drawback
claimed on the amended entries (i.e., the August 27, 1990,
amendments) was $611,369. The simple rate of error (41.24%)
should be projected to this figure, so that the total
disallowance of drawback is $252,129. Each of the protested
drawback claims should be reliquidated using this simple rate of
error.
[In its letter of September 20, 1993, in response to our
letter of July 13, 1993, requesting the protestant to provide
more information regarding this matter, the protestant again
suggested that the sample selection process used in this case was
flawed. The protestant alleges that the auditor knew that there
were deficiencies with certain parts and included those parts in
the sample, thus skewing the results. We disagree with this
allegation. According to the evidence available to us, the
sample was selected on a strictly random basis from the parts in
the claims then before Customs (and before the December 4, 1990,
amended claims were filed) and the protestant agreed to the parts
selected (also before the December 4, 1990, amended claims were
filed). Removing from the sample parts which, after the audit,
were found to have deficiencies negates the purpose of the
sampling process. Our decision in this matter is as stated
below.]
HOLDING:
The disposition of the Protest of denial of drawback
described in this ruling is as follows:
The protest is DENIED, in part, and GRANTED, in part. The
entries should be reliquidated in accordance with this decision.
In accordance with Section 3A(11)(b) of Customs Directive 099
3550-065, dated August 4, 1993, Subject: Revised Protest
Directive, this decision should be mailed by your office, with
the Customs Form 19, to the protestant no later than 60 days from
the date of this letter. Any reliquidation of the entry in
accordance with the decision must be accomplished prior to
mailing of the decision. Sixty days from the date of the
decision the Office of Regulations and Rulings will take steps to
make the decision available to Customs personnel via the Customs
Rulings Module in ACS and the public via the Diskette
Subscription Service, Lexis, Freedom of Information Act, and
other public access channels.
Sincerely,
John Durant, Director
Commercial Rulings Division