VAL RR:IT:VA 546511 CRS
Area Director
U.S. Customs Service
JFK Airport, Building 77
Jamaica, NY 11430
RE: I.A. 22/96; footwear; assists; sketches; product development; marketing and quality control
Dear Sir:
This is in reply to your memorandum of June 14, 1996, under cover of which you forwarded the above-referenced internal advice request submitted by counsel, Ross & Hardies, on behalf of Intershoe, Inc. The request was prompted by an audit of Intershoe’s consumption entries in its fiscal years 1993-1995. A copy of the audit report was forwarded with the internal advice request. This matter was also discussed at meetings between counsel and a member of my staff at Customs Headquarters on January 27, 1998, and on February 10, 1999. Certain payment information will be deleted from published versions of this decisions. We regret the delay in responding.
FACTS:
Intershoe purchases and imports women’s footwear, from various foreign suppliers, for its Glacée, Jazz, Nickels, Studio Paolo, Paloma and Via Spiga brands. In addition to the purchase price of the imported footwear, Intershoe makes payments to certain independent contractors and technical experts, including independent fashion designers and the employees of its Italian subsidiary, Mara Italia S.r.l.
The payments at issue consist of salaries and fees paid to the fashion consultants et al for certain work undertaken in connection with the imported footwear. Counsel characterizes the work performed by the fashion designers and consultants as consisting generally of product development, marketing, and quality control activities. The payments are booked to one of two accounts: salaries-design; or salaries-design-other. The services for which these payments are made are performed outside the United States.
No contracts or agreements between Intershoe and the parties involved in this transaction, i.e., Mara Italia, the independent contractors, and/or the suppliers of the imported merchandise, have been submitted in connection with this matter, with the exception of a Services Agreement, dated December 5, 1994, between Intershoe and Mr. Paolo Batacchi. Paragraph 1 of the Services Agreement provides that Mr. Batacchi will design footwear for the Via Spiga line and, specifically, that ‘[i]n his capacity as designer and fashion coordinator, [Mr.] Batacchi shall be responsible for all aspects of the design, creation development and production of footwear distributed by [Intershoe] under the Via Spiga label.” As compensation for these services, Intershoe agreed to pay Mr. Batacchi a salary and an incentive bonus.
In addition, with the exception of the Services Agreement, extracts from Intershoe’s general ledger pertaining to the “salaries-design” and “salaries-design-other” accounts, and several sketches identified as being representative of the designers’ work product, no information has been presented to substantiate the nature of the work for which the salaries and fees were paid.
As noted above, counsel characterizes the design work performed by the fashion consultants as consisting generally of product development, marketing, and quality control activities. In regard to these activities counsel has furnished the following information.
Product Development
The product development activities of the design personnel are spread over four areas: market surveys and inquiries into fashion trends in Europe and the U.S.; sketches of new styles of footwear; conversion of selected sketches into prototypes; and last development. Intershoe’s designers and design assistants furnish advice on fashion trends and create sketches of footwear styles. They suggest shapes, color, materials, accessories, etc., that will be suitable for inclusion in the Intershoe’s product line. Designers also prepare sketches; a typical designer will submit as many as 4,000 sketches yearly. Counsel advises that of these, no more than 400 are typically selected for manufacture into production footwear. Sample sketches were attached to the internal advice request as exhibits C-1 to C-4. The sketches submitted are rough, black and white drawings of shoe styles. They illustrate the general outlines of a particular style, and possible variations on a theme.
Intershoe’s design personnel review the sketches and determine which will be converted into prototypes; subsequently, they produce cardboard models of the selected sketches. The models are then supplied to manufacturers who use them to produce prototypes. Intershoe’s design personnel examine the prototypes to ensure that they are accurate representations of the sketches. Once a style is selected for development, Intershoe personnel responsible for product development work with a last factory to develop appropriate lasts for use in the manufacture of the imported footwear. The completed lasts are purchased by the vendor chosen to manufacture that particular style.
Marketing and Quality Control
Counsel asserts that payments to the “salaries-design” and “salaries-design-other” accounts also relate to various marketing and quality control activities performed by Intershoe’s employees and contractors. Marketing activities include traveling to fashion capitals to ascertain fashion trends in Europe and the United States, participation in shoe fairs in the U.S., meeting with customers, and appearing at customers’ store openings. Quality control activities consist of monitoring factory production and the inspection of finished products.
Payment amounts
Based on the information provided by counsel, the total amount booked to the two salary accounts during Intershoe’s fiscal years 1993-1995 was [$************]. Of this, the total amount paid by Intershoe directly to the fashion consultants and designers was [$**********]. Additional direct payments totaling [$*********] were made for market surveys, pattern making activities, last development and quality control services. Counsel advises that the balance of the design payments, [$***********], represents amounts paid through Intershoe’s Italian office, Mara Italia, rather than directly by Intershoe, for various design activities similar to those described above. Intershoe has not provided any information to support the allocation of the design payments between product development, marketing and quality control activities.
Dutiability
Your office contends that the work performed by Intershoe’s fashion consultants and employees, and supplied to the sellers of the imported merchandise, constitutes an assist, the value of which should be included in the appraised value of the imported merchandise. Counsel for Intershoe submits that with the exception of certain amounts paid to pattern makers, the payments at issue should not be included in the appraised value of the imported merchandise.
ISSUE:
The issue presented is whether the design work supplied by Intershoe constitutes an assist such that the value of the work, as represented by the payments made by Intershoe to its related party and to the independent fashion consultants experts, should be included in the appraised value of the imported merchandise.
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 (TAA; 19 U.S.C. § 1401a). The primary method of appraisement is transaction value, which is defined as the "price actually paid or payable for merchandise when sold for exportation to the United States," plus amounts in respect of certain statutorily enumerated additions thereto to the extent they are not otherwise included in the price actually paid or payable. The additions include the value, apportioned as appropriate, of any assist. 19 U.S.C. § 1401a(b)(1).
Transaction value is an acceptable basis of appraisement, however, only if, inter alia, the buyer and seller are not related, or if related, the circumstances of sale indicate that the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain "test values," i.e., previously accepted values of identical or similar merchandise. 19 U.S.C. § 1401a(b)(2)(B). Based on the information presented, Intershoe and the suppliers of the imported footwear are not related persons within the meaning of section 402 of the TAA; accordingly, transaction value is the appropriate basis of appraisement.
As noted above, transaction value includes the value, apportioned as appropriate, of any assist. 19 U.S.C. § 1401a(b)(1). The term "assist" refers to any goods and services supplied directly or indirectly, and free of charge or at reduced cost, by the buyer for use in connection with the production or the sale for export to the U.S. of the imported merchandise. Assists include, among other things, "engineering, development, artwork, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise." 19 U.S.C. § 1401a(h)(1)(A)(iv).
Intershoe makes payments to its subsidiary, Mara Italia, and to various independent contractors, for certain work which is furnished, free of charge, to the suppliers of the imported merchandise, free of charge. Counsel has advised that the design work performed by the employees of Mara Italia and the independent contractors includes marketing and quality control services, and product development. The work in question is undertaken outside the U.S.
Marketing and Quality Control
Marketing activities include traveling to fashion capitals to ascertain fashion trends in Europe and the United States, participating in shoe fairs, meeting with customers, and appearing at customers’ store openings. Quality control consists of monitoring factory production and the inspection of finished products.
As a general matter, neither marketing activities nor quality control services constitute assists within the meaning of section 402(h) of the TAA. However, the information presented is insufficient to determine that the activities of the designers were in fact devoted to marketing and quality control. With the exception of the Services Agreement with Mr. Batacchi, no other contracts or agreements between Intershoe and the designers involved in this transaction have been furnished. Apart from the extracts from Intershoe’s general ledger and the sketches submitted as Exhibits C1-C4, no documentation has been provided, such as employment contracts, correspondence, airline tickets, boarding passes, hotel bills, and/or job descriptions, as would support a finding that the activities of the designers included marketing and quality control. Accordingly, it is our position that the information presented is insufficient to establish that the payments at issue, recorded on Intershoe’s books as design payments, are for work not covered by section 402(h)(1)(A)(iv) of the TAA.
Product Development
Counsel submits that the activities which comprise the product development work are spread over four areas: market surveys and inquiries into fashion trends in Italy and the U.S.; sketches of new styles of footwear; conversion of selected sketches into prototypes and last development; and pattern making. To the extent that these activities constitute engineering, development, artwork, design work, and plans and sketches, the value of the work will be included in transaction value only if it was necessary for the production of the imported footwear.
1. Market Surveys
Intershoe’s designers conduct market surveys and provide advice on fashion trends. For example, they recommend shapes, colors, materials, accessories and designs they believe will be suitable for inclusion in Intershoe’s product line. Counsel contends that because this aspect of the designers’ work relates to market studies rather than to production, that it does not constitute an assist, and that the value of the work should not be included in transaction value as an addition to the price actually paid or payable.
However, in HRL 544621, dated April 22, 1991, the buyer of certain imported textiles provided colorway activity, i.e., artists’ renditions of various tone and color combinations on preexisting fabric design, free of charge to the manufacturer. The colorways instructed the manufacturer on how to color the imported textiles. In view of this, and given the skills required to produce the colorways, we found that the activity was necessary for the production of the imported merchandise such that it constituted an assist.
In the instant case, the designers recommend shapes, colors, materials, accessories and designs which they believe will be suitable for Intershoe’s product line; however, counsel submits that the work is not related to production. Nevertheless, as with the marketing activities described above, the information presented is insufficient to establish that the payments at issue, recorded on Intershoe’s books as design payments, do not constitute assists pursuant to section 402(h)(1)(A)(iv) of the TAA.
2. Sketches
In addition to surveying fashion trends, the designers prepare sketches of new shoe styles, a typical designer submitting as many as 4,000 sketches a year. Section 402 of the TAA provides that the term "assist" includes "plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise." 19 U.S.C. § 1401a(h)(1)(A)(iv).
In Headquarters Ruling Letter (HRL) 542152 (also cited as TAA No. 13), dated December 4, 1980, we held that a design drawing and crude working model, undertaken outside the U.S. and provided free of charge by the buyer, constituted an assist. In contrast, HRL 543417, dated February 11, 1985, concerned the dutiability of payments to foreign designers for sketches of houseware and kitchenware articles. The sketches were provided free of charge to the manufacturer of the imported merchandise; however, they conveyed no technical information and in many instances were altered prior to the production stage. Accordingly, we determined that the drawings were conceptual in nature and therefore did not constitute “plans and sketches” whose value should be included to the price actually paid or payable for the imported merchandise. However, in so finding we noted that given the difficulty of establishing set rules as to whether sketches and drawings constituted assists, questions of this nature could only be decided on a case-by-case basis. HRL 543417 at 2.
In HRL 544609, dated August 12, 1991, the issue was whether payments for design work and drawings were part of the price actually paid or payable for certain imported X-ray generators. There were two types of drawings: initial drawings by the engineering department; and subsequent drawings by the manufacturing department. The latter were more precise; nevertheless, we found the initial drawings were also necessary for the production of the imported merchandise.
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 certainly "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.
HRL 544609 at 4. Furthermore, we distinguished the drawings from the sketches at issue in HRL 543417, on the basis that the sketches of knives, kettles and flatware offered no assistance to the overall production of the plate. In contrast, we determined that the initial design work was significant in the case of a generator.
In the instant case, however, the information is insufficient to determine whether the work performed by the designers is or is not necessary for the production of the imported merchandise. As noted above, no contracts or agreements between Intershoe and the other parties to this transaction have been provided. Furthermore, no other documentation has been provided, apart from Exhibits C1-C4 and the general ledger material previously mentioned, which would verify the job descriptions of the persons to whom the payments were made, substantiate the nature of the work undertaken and/or support the allocation of the payments to the individual designers. Accordingly, unless evidence to the contrary is furnished, it is our position that the information presented is insufficient to establish that the payments at issue, recorded on Intershoe’s books as design payments, are for work not covered by section 402(h)(1)(A)(iv) of the TAA.
3. Sketch Conversion and Last Development
Counsel has also advised that, in addition to market surveys and sketches, the designers’ functions include the conversion of selected sketches into prototypes and last development. In regard to sketch conversion, counsel contends that once Intershoe has decided which of the sketch styles will be included in the company’s product line, the designers assist factory personnel in order to ensure that the prototype produced is an accurate realization of the initial sketch. The designers do not perform any of the work connected with manufacturing the prototypes, but merely supervise those who do. The designers perform a similar function with respect to the development of lasts.
Counsel cites HRL 544421, dated April 3, 1990, for the proposition that the assistance in respect of prototype conversion and last development do not constitute assists. In HRL 544421, the importer employed managerial personnel who served as plant managers. These personnel supervised factory operations to insure that the importer's specifications were being complied with and that the factories were operating efficiently. In addition, the importer provided a supervisory engineer who provided secondary supervision and training for mechanics and their direct supervisors. Finally, the importer provided trainers for on line assembly personnel. The salaries for these management personnel were paid by the importer and were reflected on the importer's books. We determined that the services that the salaries for the importer's management and supervisory personnel were not assists within the meaning of section 402(h)(1)(A) of the TAA. Id. at 4; see also, HRL 532992, dated September 10, 1987, HRL 543820, dated December 22, 1986.
However, in regard to sketch conversion and last development, the information presented in the instant case is insufficient to determine that the involvement of Intershoe’s personnel was merely supervisory in nature such that it was unrelated to the production of the imported footwear. Again, we note that little supporting information had been provided apart from four sketches and extracts from Intershoe’s general ledger. There are no contracts, agreements or other documents to support Intershoe’s contention that the work performed was supervisory. Accordingly, unless Intershoe is able to provide supporting documentation, it is our position that the work in question also constitutes an assist under section 402(h)(1)(A)(iv) of the TAA.
4. Pattern Making
In regard to pattern making, Intershoe’s pattern makers produce cardboard models of sketch styles selected for production. The models are furnished to the footwear manufacturers for use in the manufacture of prototypes. Counsel acknowledges that this activity constitutes design work, such that the value of the work, as represented by the appropriate portion of the payments at issue, should be included in transaction value.
Dutiability
If Intershoe is able to provide information to support its claims, e.g., that payments to certain design employees were in fact made for quality control activities, the amount of the payments should not be added to the price actually paid or payable for the imported footwear. Absent such documentation, however, it is our position that the information presented is insufficient to establish that the work performed by Intershoe’s designers and employees does not constitute an assist under section 402(h)(1)(A)(iv) of the TAA
Indeed, the available evidence, in particular the contract between Intershoe and Mr. Paolo Batacchi, coupled with the fact that the payments were recorded on Intershoe’s books as salaries paid for design work, supports a finding of dutiability. Under the terms of the Services Agreement, for example, Mr. Batacchi was “responsible for all aspects of the design, creation, development and production of footwear distributed by [Intershoe] under the Via Spiga label.” Services Agreement dated December 5, 1994, at 1. As compensation for these services, Intershoe agreed to pay Mr. Batacchi a salary and a bonus. The fact that the payments were made for footwear “design, creation, development and production” supports a finding that the design work in respect of Via Spiga footwear formed part of a design process necessary for and leading to the production and importation of those goods. These payments were recorded on Intershoe’s “salaries-design” account. As such, we find that the work constitutes an assist under section 402(h)(1)(A)(iv) of the TAA. The value of the work, as represented by the payments booked to the “salaries-design” and “saleries-design-other” accounts, should be included in transaction value as an addition to the price actually paid or payable pursuant to section 402(b)(1)(C) of the TAA.
HOLDING:
In conformity with the foregoing, the design work undertaken by Intershoe’s independent consultants and the employees of Mara Italia and supplied free of charge by Intershoe to the suppliers of the imported merchandise constitutes an assist. The value of the assist, as reflected by the payments to the Intershoe’s independent consultants and the employees of Mara Italia, should be included in transaction value as an addition to the price actually paid or payable of the imported merchandise.
This decision should be mailed to the internal advice applicant no later than sixty days from the date of this letter. On that date, the Office of Regulations and Rulings will make the decision available to Customs personnel, and to the public on the Customs Home Page on the World Wide Web at www.customs.ustreas.gov, by means of the Freedom of Information Act, and other methods of public distribution.
Sincerely,
Thomas L. Lobred
Chief, Value Branch