CLA-2 OT:RR:CTF:VS H054156 RSD
Port Director
U.S. Customs and Border Protection
1901 Crossbeam Drive
Charlotte, NC 28217-2856
RE: Request for Internal Advice; Interpretation of the Application of the Inventory
Average Method for Determining Origin of Fungible Materials and Goods
under the North America Free Trade Agreement (NAFTA), 19 CFR 181
Schedule X Part I Sections 2 and 5
Dear Port Director:
This is in response to your memorandum forwarding a letter dated January 6, 2009, from the law firm of Neville Peterson on behalf Hy-Jo Manufacturing/Tara Materials requesting that you seek internal advice. The internal advice request concerns the application of the inventory accounting method for determining the eligibility of assembled artist canvas under the North America Free Trade Agreement. A telephone conference was held with counsel and an official from Hy-Jo Manufacturing/Tara Materials on August 3, 2009. A supplemental submission from counsel dated August 19, 2009, has been received.
FACTS:
Hy-Jo Manufacturing (Hy-Jo) manufactures assembled artist canvas in Mexico that is exported to the United States. According to counsel, the merchandise that Hy-Jo exports to the United States is classified in subheading 5901.90 of the Harmonized Tariff Schedule of the United States (HTSUS). Tara Materials (Tara) is a United States manufacturer and seller of primed unassembled artist canvas. Tara exports primed unassembled artist canvas to Hy-Jo in Mexico, where the canvas is assembled into the finished product. Tara is the U.S. importer of the assembled canvas. Hy-Jo and Tara are related companies.
In order to manufacture the primed unassembled artist canvas, counsel states that Tara procures raw cotton or poly/cotton blended canvas (“material”) from third party vendors in the United States. The raw cotton or blended canvas may originate from the United States or other countries such as Turkey, Pakistan, Turkmenistan, or India. Tara identifies the country of origin of the cotton canvas at the time of its purchase. Tara considers the raw cotton canvas that it procures to be a fungible material and places the raw canvas into its inventory where it is commingled. Thereafter, Tara withdraws canvas from the inventory for priming without regard to its origin. Because it does not believe that there is any physical difference between the pieces of raw canvas, Tara does not keep track of the country of origin of the raw canvas and it cannot identify the country of origin of any particular piece of raw canvas that is placed in, and subsequently withdrawn, from its inventory.
Tara coats the raw canvas with the chemical gesso, a primer that provides a surface to paint on, as well as a barrier that prevents the artist material (oil or acrylic paint or print chemicals) from penetrating into the naturally woven fibers. Tara produces assembled artist canvas in the United States with a portion of the primed canvas.
As part of its NAFTA compliance program, Tara has adopted the inventory accounting method which is set forth in Schedule X, Part I, Section 5 (average method) of the NAFTA Uniform Regulations (codified at 19 CFR Part 181 Appendix) to determine the origin of its raw canvas material that it withdraws from inventory. Tara tracks the origin of its canvas purchases and calculates an originating/non-originating ratio, which it applies to the inventory withdrawals of the raw canvas. Tara’s ratio reflects the origin of its raw canvas purchases for a three-month period. Tara applies the ratio of originating/non-originating raw canvas materials to its primed canvas good output.
Having calculated the ratio, Tara claims that it can determine the origin of the primed canvas that it exports to Hy-Jo for assembly in Mexico. The quantity of primed canvas sent to Mexico is substantially less than the total quantity of primed canvas considered originating under the inventory average method, so Tara has designated all of the primed canvas exported to Mexico as originating goods. Therefore, Tara considers the entire amount of primed canvas sent to Mexico as originating, and consequently claimed NAFTA originating status for the entire quantity of assembled canvas that Hy-Jo produces and that Tara subsequently imports into the United States.
Customs and Border Protection’s (CBP) Office of Regulatory Audit conducted an audit of the NAFTA claims that Tara and Hy-Jo have filed. Tara, as the importer of record, filed its NAFTA claims for entries of artist canvas that Hy-Jo assembled in Mexico using the primed canvas that Tara previously
exported to it. The Office of Regulatory Audit has indicated that the ratio calculated in determining the origin of inventory withdrawals of raw canvas also governs the origin of exports of primed canvas to Mexico and the subsequent importation of assembled canvas from Mexico.
ISSUE:
Does the NAFTA average inventory accounting method permit the importer to designate all its exports of materials, for further processing in another NAFTA country and subsequent import of the finished goods as originating, as long as the exported amount is less than the amount originally calculated to be originating?
LAW AND ANALYSIS:
Pursuant to General Note 12 ("GN 12"), HTSUS, for an article to be eligible for NAFTA duty preference, two criteria must be satisfied. Firstly, the article in question must be "originating" under the terms of that General Note and secondly, the article must qualify to be marked as a good of a NAFTA country under the NAFTA Marking Rules contained in Part 102 of the CBP Regulations.
With regard to the first criteria, GN 12(b) provides, in pertinent part, as follows:
For purposes of this note, goods imported into the customs territory of the United States are eligible for the tariff treatment and quantitative limitations set forth in the tariff schedule as "goods originating in the territory of a NAFTA party" only if
they are goods wholly obtained or produced in the territory of Canada, Mexico and/or the United States; or they have been transformed in the territory of Canada, Mexico, and/or the United States so that except as provided in subdivision (f) of this note, each of the non-originating material used in the production of such goods undergoes a change in tariff classification described in subdivisions (r), (s) and (t) of this note or the rules set forth therein,
or
the goods otherwise satisfy the applicable requirements of subdivisions (r), (s) and (t) where no change in tariff classification is required, and the goods satisfy all other requirements of this note; or they are goods produced entirely in the territory of Canada, Mexico, and/or the United States exclusively from originating materials.
The assembled artist canvas exported from Mexico is classified in subheading 5901.99, HTSUS, and the artist canvas used to produce the assembled artist canvas is also classified in 5901.90.40, HTSUS. General Note 12(t), HTSUS provides for a change to heading 5901 from any other chapter, except from heading 5111 through 5113, 5208 through 5212, 5310 through 5311, 5407 through 5408 or 5512 through 5516. Therefore, the artist canvas produced by Tara and exported from the U.S. to Mexico must be considered originating. Your office indicates that the foreign milled fabric of 100 percent cotton, poly/cotton and 10 percent polyester used in the manufacturing of the primed canvas in the U.S. does not undergo the applicable tariff shift requirements for the NAFTA preference of General Note 12(t). Consequently, only primed canvas produced in the U.S. from U.S. originating fabric will be considered originating under the NAFTA.
As indicated, Tara procures raw cotton or poly cotton blended canvas that may originate in the U.S. or other countries such as Turkey, Pakistan Turkmenistan, or India. According to counsel, the originating and non-originating raw canvas is fungible and is commingled together in inventory that Tara maintains in the U.S. The term “fungible” is defined by the NAFTA in General Note 12(g), HTSUS (10 U.S.C 1202) as meaning that the particular materials or goods are interchangeable for commercial purpose and have essentially identical properties. NAFTA in GN 12(g), HTSUS (19 U.S.C. 1202) further provides that:
(i) where originating and non-originating fungible materials are used in the production of a good, the determination of whether the materials are originating need not be made through the identification of any specific fungible material, but may be determined on the basis of any of the inventory management methods set out in regulations promulgated by the Secretary of the Treasury; and
(ii) where originating and non-originating fungible goods are commingled and exported in the same form, the determination may be made on the basis of any of the inventory management methods set out in regulations promulgated by the Secretary of the Treasury.
19 CFR Part 181 Part IV Section 7 provides that: Materials
(16) Subject to subsection (16.1), for purposes of determining whether a good is an originating good,
(a) where originating materials and non-originating materials
that are fungible materials
are withdrawn from an inventory in one location and used in the production of the good, or
are withdrawn from inventories in more than one location in the territory of one or more of the NAFTA countries and used in the production of the good at the same production facility, the determination of whether the materials are originating materials may be made on the basis of any of the applicable inventory management methods set out in Schedule X…
As this is a request for internal advice and the request was made to determine the application of the inventory management method, we will assume for the purposes of this decision that the raw canvas used in making the primed canvas in the U.S. is in fact fungible. We note, however, that no information concerning this issue was submitted or raised by your office.
For determining which portion of the primed canvas is originating or non-originating for purposes of the NAFTA, specific identification is not required, but an inventory management method prescribed in the Appendix to 19 CFR 181 of the CBP Regulations may be used. Schedule X of the Appendix sets forth the four inventory management methods for determining whether fungible materials or fungible goods are originating. These methods are: (a) specific identification method; (b) FIFO method; (c) LIFO method; and (d) average method.
In applying the average method, Tara tracks the origin of its canvas purchases and calculates an originating/non-originating ratio. Tara’s ratio reflects the origin of its raw canvas purchases for a three–month period. As an example, counsel explains that if the ratio of originating/non-originating raw canvas withdrawn from inventory for coating is 70/30 (measured by square meters) for a given period, Tara considers that its primed canvas has the same 70/30 ratio (again, measured by square meters). Therefore, if Tara withdraws 1,000,000 square meters of raw canvas from inventory during that period, with which it produces 1,000,000 square meters of primed canvas, it has 700,000 square meters of originating primed canvas and 300,000 square meters of non-originating primed canvas. Counsel claims that having calculated the ratio, Tara is in a position to determine the origin of the primed canvas that it exports to Hy-Jo for assembly in Mexico. The quantity of primed canvas shipped to Mexico is substantially less than the total quantity of originating primed canvas determined under the inventory average method, so Tara has treated all of the primed canvas exported to Mexico as originating merchandise. For purposes of this decision, we assume the ratio calculation is correct, as this has not been identified as a question for us to decide.
Tara believes that the ratio calculated under the materials inventory average method identifies the maximum quantity of originating merchandise available to the Mexican producer. Tara’s interpretation is that the applicable regulation permits the Mexican producer to claim originating status for cross-border shipments of the full quantity of goods that it produces. Tara acknowledges that it cannot claim originating status for a greater quantity of goods produced from the primed canvas than it withdrew from its inventory as determined under the average method.
In contrast, the Office of Regulatory Audit believes that the ratio of originating materials to non-originating materials calculated under the average method must be applied to each shipment of finished assembled canvas imported into the United States. This means that a portion of every withdrawal, use, or shipment will contain a percentage of both originating and non-originating materials/goods, the sum of which equals one-hundred percent. Consequently, the NAFTA preference would be available only for the portion of each shipment which was determined to be originating, in accordance with the ratio.
The applicable regulations 19 CFR Part 181 Schedule X provides the methodology for determining the ratio of originating to non-originating materials that are considered fungible, but give no guidance on how the ratio of originating to non-originating goods may be allocated when those goods are used to make other goods in another NAFTA country for subsequent importation to the U.S. We are of the opinion, that the various inventory management methods on fungibility were enacted as part of the NAFTA in order to eliminate the burden and expense for importers of having to physically segregate originating and non-originating fungible goods and materials. We note that if materials were physically segregated, all originating goods made from those materials could be exhausted in order to produce other originating materials before non-originating goods had to be withdrawn from inventory. Because the inventory management methods in the NAFTA are intended to be substitutes for specific identification, we are in agreement with Tara’s position that the amount of originating goods it calculates under the inventory average method represents a maximum quantity of originating merchandise available to the Mexican producer. Therefore, we also conclude that the ratio as calculated under the average method does not have to be applied to every shipment of assembled artist canvas that is subsequently imported into the United States. As such, Tara can designate all the primed canvas that it has shipped to Mexico for the applicable period of time as NAFTA originating until the amount of originating materials calculated by the originating to non-originating ratio has been exhausted. As a producer, Tara may apply the ratio to its primed canvas goods and completed Certificated of Origin based on the ratio for sale to its customers in accordance with their subsequent use of those goods. We note, however, and counsel has confirmed that if the average method is properly interpreted and calculated, subsequent periods should not disproportionately skew the availability of originating goods, as a new ratio would be determined based upon the subsequent purchase of raw canvas. The reason for this is that the prime canvas is a good, and the raw canvas is considered a material and they are not considered fungible. Finally, we note that none of the articles discussed involved a calculation of a regional value content which could affect the subsequent eligibility under NAFTA.
HOLDING:
For the reasons stated above, the average method for fungible materials under the NAFTA as set forth in 19 CFR 181 Schedule X, identifies the maximum quantity of originating materials available for the applicable time period to the Mexican producer for producing the assembled artist canvas and subsequently imported to the United States. The ratio of non-originating materials that is calculated under the NAFTA average method in this case does not have to be applied to each shipment of finished assembled artist canvas.
Please promptly provide a copy of this ruling to the internal advice requester. Sixty days from the date of this ruling the office of Regulations and Rulings will make the decision available to CBP personnel, and to the
public on the CBP Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.
Sincerely,
Monika R. Brenner
Chief, Valuation and Special Programs Branch