VAL CO:R:C:V 544662 CRS
Area Director of Customs
New York Seaport
U.S. Customs Service
6 World Trade Center
New York, NY 10048
RE: Internal Advice Request *****; Pre-Penalty Case 89-1001-
*****
Dear Madam:
This is in reply to the subject internal advice request,
filed on behalf of *** (the "buyer), by counsel
******************************* on February 22, 1991. In
addition, a submission dated June 14, 1991, was filed in response
to the pre-penalty case referred to above. The file contains
voluminous correspondence on this matter including submissions
dated, respectively, March 6, 1986, March 10, 1989, and September
12, 1989. Meetings to discuss this matter were held with counsel
on July 30, 1992, and January 25, 1994. The latter meeting was
attended by a representative from the Regulatory Audit Division,
New York, and by a Headquarters representative of the Office of
Regulatory Audit. Our comments in regard to the appraisement
issues raised in the internal advice request follow. We regret
the delay in responding.
FACTS:
The buyer imports children's wearing apparel from its
wholly-owned Philippine subsidiary, ************* (the "seller").
The buyer supplies the seller with fabric, trim and accessories
on a consignment basis, which materials the seller uses to
manufacture wearing apparel. The invoices that accompany the
seller's shipments state a dollar value for each style of
garment; however, this amount is not actually paid by the
importer. Instead the buyer makes regular payments to the seller
in varying amounts in addition to furnishing the seller with the
materials specified above.
In 1988 the Regulatory Audit Division, New York (the
"auditors"), audited entries filed by the buyer between May 1,
1980, and April 30, 1985. The auditors concluded that the buyer
undervalued entries filed during the period in question by
$************* resulting in a loss of revenue of $************
(Audit Report 2-88-CEF-03, dated March 2, 1988, at 13).
Specifically, the audit report identified the following areas in
which the buyer's costs were undervalued: "material assists,"
undervalued by $550,667.00; "labor, overhead and profit,"
undervalued by $************; "assists," undervalued by
$************; and "second quality" merchandise, undervalued by
$************.
In response, the buyer filed a prior disclosure and tendered
a total of $************, in checks of equal amount dated July 2,
1985, and September 3, 1985. The auditors subsequently revised
their calculations and determined that the actual undervaluation
was $************, resulting in a loss of duty was $************.
The amount of material undervaluation remained unchanged;
however, the undervaluation of labor, overhead and profit was
revised downward to $************ and the undervaluation of
assists was reduced to $************. The undervaluation of
"second quality" merchandise was eliminated from the loss of duty
calculation. In a letter dated May 23, 1991, counsel tendered a
check for an additional $**********, on behalf of the buyer.
This payment perfected the prior disclosure. Pursuant to a pre-
penalty notice dated June 5, 1991 (which superseded the original
pre-penalty notice of January 11, 1991), the amount of the
proposed monetary penalty relating to this matter was set at
$************.
In its submissions of February 22, and June 14, 1991,
counsel takes issue with the audit findings. First, it maintains
that in calculating the value of material assists provided by the
buyer to the seller, the audit overstated the buyer's material
costs by $************. Second, in regard to labor, overhead and
profit, counsel contends that certain packing costs, penalty
payments, supervisory charges and tax credits should not be
included in the appraised value of the merchandise. Finally,
counsel asserts that the audit report overstates the value of
certain other assists. In light of the above, counsel maintains
that the buyer's entries during the period in question reflect a
loss of revenue of no more than $**********, rather than the loss
of $************ determined by the audit. Counsel therefore
contends that the buyer is entitled to a refund of at least
$************.
Furthermore, while the issue of second quality merchandise
was dropped from the pre-penalty case, counsel urges in regard to
future shipments that Customs "continue its longstanding practice
of appraising the buyer's 'seconds' at 50 percent of the value of
its first quality garments."
ISSUES:
The appraisement issues presented by the instant advice
internal request are: (1) whether transaction value is the
appropriate basis of appraisement; (2) whether the amount of the
undervaluations determined pursuant to the audit report are
properly included in the transaction value of entries filed by
the buyer during the period in question; and (3) whether second
quality merchandise should be appraised at fifty percent of the
value of first quality garments?
LAW AND ANALYSIS:
Merchandise imported into the United States is appraised in
accordance with section 402 of the Tariff Act of 1930, as amended
by the Trade Agreements Act of 1979 (the TAA; 19 U.S.C. 1401a).
The preferred method of appraisement under the TAA is transaction
value, defined as "the price actually paid or payable for the
merchandise when sold for exportation to the United States," plus
certain additions, including packing and the value, apportioned
as appropriate, of any assist. 19 U.S.C. 1401a(b)(1).
However, imported merchandise is appraised under transaction
value only if the buyer and seller are not related, or if they
are related, the transaction value is deemed acceptable. Section
402(b)(2)(B) of the TAA provides that a transaction value between
a related buyer and seller is acceptable if the circumstances of
sale indicate that the relationship did not influence the price
actually paid or payable. Alternatively, a transaction value
between related is acceptable if it closely approximates, inter
alia, the deductive or computed value (test values) for identical
or similar merchandise. 19 U.S.C. 1401a(b)(2)(B).
the seller is the buyer's wholly-owned subsidiary.
Accordingly, the seller and the buyer are related parties within
the meaning of section 402(g) of the TAA which provides, inter
alia, that an organization, and any person directly or indirectly
owning, controlling, or holding with power to vote, 5 percent or
more of the outstanding voting stock or shares of that
organization, are related. 19 U.S.C. 1401a(g)(1)(F).
In the instant case the "circumstances of sale" between the
buyer and the seller do not validate the use of the transaction
value. For example, we understand that payments by the buyer to
the seller bear no direct relationship to the invoice value of
the imported merchandise. Moreover, the manner in which the
buyer invoices "second quality" merchandise suggests that the
relationship influences the price actually paid or payable.
However, the Area Director, Newark, New Jersey, has advised that
the transfer prices, i.e., the invoice values of the entries in
question, closely approximates the computed value of identical
merchandise. The situation is similar to that in Headquarters
Ruling Letter (HRL) 542580 (also cited as TAA No. 41) dated
November 4, 1981. There the transfer price represented the
seller's full cost of materials, direct labor, overhead, and
general expenses and profit. Accordingly, we held that the
transfer price would closely approximate the computed value of
identical merchandise, thereby validating the use of transaction
value. It was first necessary actually to appraise an initial
importation on the basis of computed value in order to establish
the test value. See also, HRL 544375 dated July 16, 1990.
Similarly, the transfer prices of the imported garments in
the instant case were compared to previously accepted computed
values. As a result of this comparison the transfer prices were
determined closely to approximate the computed value of identical
merchandise, provided certain additions were made to the invoice
prices. Accordingly, transaction value is an acceptable basis on
which to appraise the entries in question.
As stated above, transaction value is defined as the price
actually paid or payable for the merchandise when sold for
exportation to the United States. For the purposes of section
402, the term "price actually paid or payable" is defined as
follows:
(A) The term "price actually paid or payable"
means 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 the
merchandise from the country of exportation to the
place of importation in the United States) made, or to
be made, for imported merchandise by the buyer to, or
for the benefit of the seller.
19 U.S.C. 1401a(b)(4)(A).
Material Costs
The buyer provides the seller, the seller, with materials
used in the production of finished garments including fabric,
trim and accessories. The audit reports concludes that the
buyer's claim in regard to material losses should not be allowed
because the adjustments to the books were made after the date of
the audit and are not supported by documentary evidence.
However, counsel contends that the audit report overstates the
buyer's material costs by not including these adjustments and
submits that this position is supported by the seller's accounts.
Specifically, counsel asserts that material losses should not be
included in the value of assists furnished by the buyer. The
material losses are allegedly attributable to: (1) year-end
adjustments to inventory, lost garments charged to contractors,
the cost of yarn burned in 1982, and thread not included in 1984
inventory; (2) adjustments for materials returned to the buyer;
(3) samples; (4) credit memos on the buyer's books; (5)
differences reflected on a discrepancy report totaling $******
(Exhibit 22 of counsel's submission of June 14, 1991); and (6)
adjustments in regard to the buyer's invoice no. 83/4525 (Exhibit
C). Submission of June 14, 1991, at 8-10.
The term "assist" refers to certain items supplied directly
or indirectly, and free of charge or at a reduced cost, by the
buyer of imported merchandise for use in connection with the sale
for export to U.S. of the merchandise. Under transaction value,
the value of assists, apportioned as appropriate, are an addition
to the price actually paid or payable. Pursuant to section
402(h)(i) of the TAA the term "assist" includes, inter alia,
"materials, components, parts, and similar items incorporated in
the imported merchandise." 19 U.S.C. 1401a(h)(i). The
materials furnished by the buyer to the seller include fabric,
trim and accessories incorporated in the imported merchandise.
Accordingly, the materials furnished by the buyer constitute
assists.
The audit report notes that one adjustment to the cost of
material assists was made for a shipment that had been
highjacked. This adjustment was documented by an insurance
claim. Nevertheless, in regard to the balance of the material
assist costs, the audit report states that the claimed
adjustments were not reflected in the buyer's accounts as of the
date of the audit and, consequently, were disallowed. This issue
was extensively discussed at the January 25, 1991, meeting. In
support of the buyer's position, counsel submitted documentation
consisting of excerpts from the seller's December 31st and
January 1st trial balances for the period in question. Counsel
has also cited HRL 543093 for the proposition that materials that
are destroyed, scrapped, lost and are not physically incorporated
into imported merchandise are not assists under the TAA.
In light of the information presented by counsel we are
persuaded that the claimed adjustments were properly recorded on
the books of the seller and that the buyer's material assists
were therefore not overstated. Consequently, pursuant to HRL
543093, the value of the materials destroyed and not otherwise
incorporated into merchandise imported during the period in
question, viz., $550,677.00, should not be included in the
appraised value of the imported merchandise.
Labor, Overhead and Profit
Counsel contends that certain other costs identified
generally by the audit report under the rubric of "labor,
overhead and profit" should not be included in the appraised
value of the imported merchandise. These include the cost of
"Redipak" packing, and van stuffing and palletizing, as well as
certain fines and penalties, supervisory charges and tax credits.
The "Redipak" process is undertaken after finished garments
made by the seller come off the assembly line and have been
packed in cartons of twenty or more dozen per carton. From the
assembly line the cartons containing the garments are taken to an
apparently adjoining or nearby location within the plant, and
unpacked. There the garments are placed on hangers, wrapped with
tissue paper, placed in polybags and packed in boxes holding
between six and twelve garments. The costs of the "Redipak"
process are borne by the buyer and the service is performed at
its request.
Counsel maintains that the finished garments are packed in
seaworthy condition, packed ready for shipment to the U.S. before
the additional process of preparing them for retail display is
undertaken, i.e., before they are submitted to the "Redipak"
process. In support of this position counsel cites HRL 542957
dated November 26, 1982, HRL 543026 dated March 17, 1983, and HRL
543985 dated February 1, 1988. These rulings hold generally that
where merchandise is packed in ocean containers, on hangers, on
racks, in condition ready for shipment to the U.S., payments to
third parties for a vacuum packing operation similar to "Redipak"
would not be included in the appraised value of the imported
merchandise. Consequently, counsel asserts that the cost of the
"Redipak" process is not included in the transaction value of the
imported merchandise.
Packing costs are an addition to the price actually paid or
payable (19 U.S.C. 1401a(b)(1)(A)) and are defined by section
152.102, Customs Regulations which provides:
(e) Packing costs. "Packing costs" means the total
cost of all containers (exclusive of instruments of
international traffic) and coverings of whatever nature
and of packing, whether for labor or materials, used in
placing merchandise in condition, packed ready for
shipment to the United States.
19 C.F.R. 152.102(e).
In HRL 542834 dated July 20, 1982 (TAA No. 49) a seller of
imported merchandise placed goods on racks or hangars at the
factory. In a separate transaction, the importer/buyer of the
merchandise contracted with an unrelated third party to collect
the goods from the seller, deliver them to a packaging plant
where they were vacuum packed and placed in export containers or
on pallets, and then deliver them to a carrier for international
shipment. Citing to a prior ruling (HRL 400077), we noted that
the importer/buyer had the burden of establishing that the
merchandise is packed ready for shipment, i.e., in a seaworthy
condition, prior to being placed in a container. Based on the
facts in HRL 542834 we held that the merchandise was not packed
ready for shipment and, therefore, that the cost of vacuum
packing, etc., were part of packing costs and should be included
in the appraised value of the merchandise. See also HRL 544993
dated October 9, 1992.
In the instant case, the "Redipak" process is performed by
the seller, the buyer's wholly-owned subsidiary, rather than by
an unrelated third party. Where we have held that the cost of
vacuum packing was not part of the price actually paid or payable
for imported merchandise, payment therefor has been made to an
unrelated third party. Secondly, no documentation or other
evidence has been submitted to establish that the first packing
operation is sufficient to place the garments in a seaworthy
condition such that they would be considered ready for shipment
to the U.S. Indeed, we are advised by the concerned National
Import Specialist and the Office of Trade Operations that what is
described as the "bulk packing" operation is in all likelihood
simply a method of moving finished garments from the production
line to the place where the garments packed. Accordingly,
counsel has not met the burden of establishing that the garments
were packed ready for shipment prior to being submitted to the
"Redipak" process. Thus the "Redipak" process, rather than being
additional packing, is in fact the sole method of packing the
garments for shipment to the U.S. Packing costs are an addition
to the price actually paid or payable. 19 U.S.C.
1401a(b)(1)(A). Accordingly, costs related to the "Redipak"
process were properly included in the transaction value of the
entries in question.
Counsel also maintains that the cost of "van stuffing and
palletizing" performed by the seller should not be included in
transaction value. These amounts include the cost of placing
Redipak cartons on pallets, strapping the cartons to the pallets,
and placing the pallets into vans or containers. In support of
its position counsel cites HRL 543518 dated September 3, 1985, in
which we held that certain loading charges were incidental to
international shipment and therefore not dutiable. We note,
however, that our decision in that case was influenced by the
fact that in some instances the loading charges were included as
an indivisible amount in the freight charges. This is not the
case here. Moreover, in HRL 542834 we stated that the placement
of merchandise on pallets should be included in the addition for
packing since the cost was incident to placing the merchandise in
condition, packed, ready for shipment to the U.S. Accordingly,
it our position that the van stuffing and palletizing costs are
incident to placing the garments in condition, packed ready for
shipment and are part of the price actually paid or payable.
The final elements of the "labor, overhead and profit"
category identified in the audit report consist of amounts for
fines and penalties, supervisory charges, and "BOI tax credits."
Based on the information presented by counsel it is our position
that these amounts should not be included in the appraised value
of the merchandise.
Assists
The auditors initially determined that the buyer undervalued
"assists," other than material assists totaling $************.
Subsequently it was determined that $************ relating to
supervisory salaries was not dutiable, thereby reducing the
undervaluation of "assists" to $************. Letter from Fines,
Penalties and Forfeitures dated April 22, 1991. Counsel has
stated that "[i]ncluded in this total are certain costs relating
to insurance, equipment, parts, and salaries, all of which the
buyer agrees are dutiable." Submission of June 14, 1991, at 21-
22. Since counsel has not raised any further questions
concerning the inclusion of these costs we have no further
comments in regard to this issue.
Defective Merchandise
In its submission of February 22, 1991, counsel raised a
question in regard to the valuation of second quality garments
which it states that the buyer resells in the U.S. at fifty
percent of the regular sales price for such garments. The buyer
entered these second quality garments at reduced values,
generally fifty percent of first quality merchandise. Counsel
stated that this practice was disclosed to, and accepted by,
Customs at the time of entry, and therefore maintained that
Customs should abandon its claim for increased duties in this
regard.
This claim was in fact dropped from the pre-penalty
proceeding. Nevertheless, in its submission of June 14, 1991,
counsel states that "[w]hile the Customs Service has agreed that
the penalty period loss of revenue should not be increased to
reflect first quality prices for second quality goods...it is our
understanding that [Customs] wished to revisit this issue in the
context of current shipments." Submission of June 14, 1991, at
33-34. In view of this, counsel restated its contention that the
buyer's practice of entering "second quality" merchandise at
fifty percent of the value of first quality merchandise was in
conformity with the law and regulations.
The buyer's merchandise is appraised under transaction
value, i.e., on the basis of the price actually paid or payable
by the buyer to the seller, plus the enumerated additions, to the
extent applicable, but exclusive of the cost of international
transport. Section 402 of the TAA does not distinguish between
different classes of merchandise, e.g., between first and second
quality goods. Accordingly, there is no authority under the TAA
for the buyer to enter is "second quality" merchandise at fifty
percent of the value of first quality merchandise. However, when
imported merchandise is defective, an allowance may be made.
In this regard, section 158.12, Customs Regulations (19
C.F.R. 158.12), provides in pertinent part:
(a) Allowance in value. Merchandise which is subject
to ad valorem or compound duties and found by the
district director to be partially damaged at the time
of importation shall be appraised in its condition as
imported, with an allowance made in the value to the
extent of the damage....
In order for an allowance to be made the buyer/importer must
provide Customs with clear and convincing evidence to support a
claim that merchandise purchased and appraised as one quality was
in fact of a lesser quality. C.S.D. 84-12, 18 Cus. B. & Dec.
849, 852 (1984). If there is nothing to substantiate an
assertion that merchandise is defective, then no allowance may be
made. HRL 544879 dated April 3, 1989.
Accordingly, in regard to future entries, unless the buyer
presents acceptable evidence that merchandise is in fact
defective, no allowance in value may be made.
HOLDING:
The transfer price between the buyer and the seller closely
approximates the computed value of identical merchandise and
transaction value is therefore the appropriate basis of
appraisement for the buyer's entries during the period in
question.
The adjustments to the value of the material assists at
issue were properly recorded on the seller's books and do not
represent the undervaluation of the entries in question.
Similarly, amounts for fines and penalties, supervisory charges,
and BOI tax credit, identified in the audit report under the
general heading of "labor, overhead and profit," should not be
included in the undervaluation of the entries in question.
Packing expenses as represented by charges for the "Redipak"
process and for "van stuffing and palletizing," which also were
identified in the audit report under the general heading of
"labor, overhead and profit," were undervalued in the amounts
specified in the audit report. Non-material "assists," that
pertain to insurance, equipment, parts and salaries, but not to
supervisory salaries, were also undervalued in the amount
specified by the audit report, as modified by the letter from
Fines, Penalties and Forfeitures dated April 22, 1991.
Allowances for defective merchandise should be made by the
concerned import specialist pursuant to 19 C.F.R. 158.12, only on
the basis of sufficient evidence.
This decision should be mailed by your office to the
internal advice requester no later than sixty days from the date
of this letter. On that date 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~, the Freedom of
Information Act and other public access channels.
Finally, since a pending action under 19 U.S.C. 1592 is
involved we would appreciate expedited treatment of this matter.
Sincerely,
John Durant, Director
Commercial Rulings Division