HQ 0544067 - Entry of Network Interface Device Subassemblies under the Caribbean Basin Initiative - United States International Trade Commision Rulings

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HQ 544067

June 12, 1989

CLA-2 CO:R:C:V 544067 BJO

CATEGORY: CLASSIFICATION

Mr. Jeffrey G. Wood
GTE Sylvania Special Products, Inc.
P.O. Box 780
Luquillo, Puerto Rico 00673

RE: Entry of Network Interface Device Subassemblies under the Caribbean Basin Initiative

Dear Mr. Wood:

This is in response to your letters of September 10, 1987 and December 16, 1988, concerning a ruling that Haitian-assembled Network Interface Device subassemblies qualify for duty-free entry under the Caribbean Basin Economic Recovery Act (CBERA)(19 U.S.C. 2701-2706). We regret the delay in responding to your request.

FACTS:

You state that each subassembly is made in Haiti, and includes 38 component parts of Puerto Rican and U.S. origin. Upon completion, the subassemblies are shipped directly to the U.S., where they are used in the manufacture of telephone network interface devices. You further state that the value of the U.S. components used in the production of each subassembly exceeds 15% of the appraised value of each article, and that the value of the components manufactured in Puerto Rico exceeds an additional 15% of each article's value.

The major features of the Haitian assembly process, which you state involve 19 different operations and 50 individual procedures, are as follows:

1. Ring terminals and gold wire splices are crimped with a crimping machine to opposite ends of each of four pre-cut insulated wires, which are then inserted by hand and staked with a seat lead fixture through a prefabricated base. On the reverse side of the base, the gold wires protruding from the staked wires are plunged with a contact wire fixture into a cavity in the base, forming contact wires.

2. The staked wires are bent to the side of the base with a hand tool, and, with an ultrasonic welder, the wires are capped at the base with a plastic piece. Each wire is then tested with a jack short tester for continuity.

3. The jacket of a separate cable is trimmed by hand with an X-acto knife and the cable is inserted through a pre-cut hole in the base. A plug is attached to the trimmed end of this cable by means of a crimping fixture and pliers. The other end of the cable is trimmed and a square terminal is crimped to each of the 4 insulated wires contained within the cable jacket. Epoxy encapsulant is injected into both sides of the plug lead-in and to the cavity of the base where the cable had been inserted, and the entire base assembly is baked for one hour to solidify the epoxy.

4. A four-color adhesive strip is applied to the base. The four square terminals are pulled through the base and attached with screws according to the color strip to four pre-cut holes in the reverse side of the base.

5. A pre-cut "pigtail" cable containing four insulated wires is crimped at one end with four spade terminals, and each of these 4 terminals, as well as the four ring terminals described in the first step, are attached by power screwdriver to 4 pre-cut points on the base. A gasket is then applied to the face of the plug described in step 3 above, and the base assembly is tested for short and open circuits.

6. Three-eighths of one inch of the insulation of three of the four wires contained in the pigtail is hand stripped, a resistance test is performed on the pigtail wires, excess epoxy is removed with the X-acto knife, a UL sticker is added, a retaining screw is inserted into a pre-cut hole in the base, a retainer is attached, quality control performed, and the assembly is packed for shipment.

You advise that the direct cost of the above described processing operations is equivalent to 18.4% of the subassembly's total value, if the following cost components are included within the direct cost computation:

1. Direct labor and associated fringe benefits.

2. Indirect labor, including material handlers, group leaders, and quality control inspectors, and associated fringe benefits.

3. Electricity used for manufacturing equipment.

4. Haitian inland freight and brokers fees associated with the raw materials used.

5. Manufacturing foreman and associated fringe benefits.

6. Equipment maintenance personnel and associated fringe benefits.

7. Quality Control supervisor and associated fringe benefits.

8. Cost of transportation provided to direct labor employees.

9. Depreciation on machinery and equipment.

You state that the following costs have not been included as direct processing costs:

10. Profit

11. Telephone and telex expenses.

12. Office supplies.

13. Facility maintenance expenses.

14. Electricity consumed for lighting and office air conditioning.

15. Auto and truck expenses.

16. Plant manager and associated fringe benefits.

17. Facility maintenance personnel and associated fringe benefits.

18. Accounting personnel and associated fringe benefits.

19. Industrial engineer and associated fringe benefits.

20. Shipping and receiving personnel and associated fringe benefits.

21. Taxes and insurance expenses.

22. Plant security.

23. Other miscellaneous expenses.

Finally, your letter states that the subassemblies have been manufactured at your company's facility in Haiti, which has a labor force of nearly 800, and have been entered under item 685.90, Tariff Schedules of the United States.

ISSUE:

I. Whether the subassemblies assembled in Haiti from components manufactured in Puerto Rico and the U.S. are products of Haiti for purposes of the CBERA.

II. Whether the costs involved in assembling the subassemblies in Haiti are direct costs of processing operations for CBERA purposes.

LAW AND ANALYSIS:

Under the CBERA, eligible articles the growth, product, or manufacture of a beneficiary country ("BC") which are imported directly to the U.S. from a BC qualify for duty-free treatment, provided the sum of (1) the cost or value of materials produced in a BC or two or more BC's, plus (2) the direct costs of processing operations performed in a BC or countries is not less than 35% of the appraised value of the article at the time it is entered. See 19 U.S.C. 2703(a)(1).

Haiti is a BC under CBERA, and the imported subassembly is CBERA-eligible. Your letter indicates that the articles are imported directly to the U.S. Accordingly, the articles may be entered duty-free under CBERA if they are products of Haiti, and if the 35% value-content requirement is met.

I. "Product of" Requirement

An article assembled in a BC from materials originating from outside the BC, as here, is the "growth, product, or manufacture" of the BC if the non-BC materials are substantially transformed in the BC into a "new and different article of commerce." See 19 CFR 10.195(a)(1).

We find that the Haitian assembly operation substantially transforms the materials imported into Haiti into a new and different article of commerce. A substantial transformation occurs "when an article emerges from a manufacturing process with a name, character, or use which differs from those of the original material subjected to the process." See The Torrington Co. v. United States, 764 F.2d 1563, 1568 (Fed. Cir. 1985). In determining whether the combining of parts or materials constitutes a substantial transformation, the issue is the extent of operations performed and whether the parts lose their identity and become an integral part of a new article. Belcrest Linens v. United States, 741 F.2d 1368, 1373 (Fed. Cir. 1984) If the combining process is merely a minor one which leaves the identity of the imported article intact, a substantial transformation has not occurred. Uniroyal, Inc. v. United States, 542 F.Supp.1026, 1029 (CIT 1982), aff'd, 702 F.2d 1022 (Fed. Cir. 1983); see also 19 C.F.R. 10.195 ("No article or material shall be considered to have been grown, produced, or manufactured in a beneficairy country by virtue of having undergone simple (as opposed to complex or meaningful) combining or packaging operations.").

In C.S.D. 85-25, we found that an assembly operation was "complex and meaningful" in view of:

"a very large number of components, a significant number of different operations, [which] required a relatively significant period of time, as well as skill, attention to detail and quality control, and...significant economic benefit to the BC from the standpoint of both value added to each article, and the overall employment generated thereby."

The assembly process described in your letter also involves a significant number of components and assembly procedures, and requires use or operation of a number of different tools and pieces of equipment, and consequent skill and attention to detail. In addition, the resultant economic benefit to Haiti appears significant in light of your statement that the Haitian production facility employs 800 workers, and the per item direct cost of the processing is equivalent to 18.4% of the total value of the article.

As a result of the Haitian assembly operation, the subassembly is a new article which has a distinct electronic function apart from its component parts, and is ready for incorporation into a telephone network interface device when
completed. Further, the component materials, such as the insulated wires, cable, plug, terminals, and bare base assembly, lose their own identity and become integral parts of the subassembly. In The Diamond Match Company v. United States, 49 CCPA 52 (1961), the court found that wooden sticks, which had been inserted into ice cream and frozen to form "ice-cream-on-a- stick," lost their identity and became integral parts of the new article because the new article could not function without them, and the sticks could not be removed without destroying the product. In a similar manner, subassembly here will not function without the component parts, and the component parts are physically altered and permanently affixed in the new article. For these reasons, we find that the subassemblies are products of Haiti for purposes of CBERA.

II. The 35% Value-Content Requirement

The CBERA provides that the cost or value of materials incorporated in the final article which are produced in the customs territory of the U.S., excluding Puerto Rico, may be included in the 35% value-content calculation, but in an amount not to exceed 15% of the appraised value of the article at the time it is entered. See 19 U.S.C. 2703(a)(1). The cost of materials produced in Puerto Rico may be applied to satisfy the 35% value-content requirement without limitation. Id. You may therefore apply all costs of materials which are produced in Puerto Rico and incorporated in the subassemblies toward the 35% value-content minimum; the 15% cap applies only to costs of materials produced in the customs territory of the U.S. other than Puerto Rico.

"Direct costs of processing operations" are those costs which are either directly incurred in, or which can be reasonably allocated to, the growth, production, manufacture, or assembly of the specific merchandise under consideration. See 19 CFR 10.197(a). They include "all actual labor costs involved in the growth, production, manufacture, or assembly of the specific merchandise, including fringe benefits, on the job training, and the cost of engineering, supervisory, quality control, and similar personnel." See 19 CFR 10.197(a)(1). Profit and general expenses of doing business, such as administrative salaries and casualty and liability insurance are not direct costs of the processing operation. See 19 CFR 10.197(b).

The salaries, wages, and fringe benefits of those workers, including quality control inspectors, who are directly engaged in
the production of the subassemblies may be included in the 35% value-content requirement as a direct cost of the processing operation. See C.S.D. 80-246, dated April 23, 1980 (HQ 542097)(Salaries, wages, fringe benefits of production workers are direct costs for purposes of the GSP).

The costs of transportation provided to direct labor employees is a direct processing cost. See HQ 554246, dated July 29, 1987 (Expenses incurred in transporting personnel to and from the production facility to render services which are directly related to the production process are includable as direct processing costs for purposes of the CBERA.)

Compensation, including fringe benefits, of material handlers and shipping and receiving employees is also includable to the extent it is for handling of materials used in the production of the subassemblies, or the finished subassemblies themselves. See C.S.D. 80-208, dated March 24, 1980 (HQ 542035)(Cost of employees who receive, unload, and stock raw materials in manufacturer's plant, distribute materials to assembly line, maintain storage area and raw material inventory records, and pack and prepare the eligible articles for shipment are direct costs of processing operations for GSP purposes).

Compensation of group leaders, quality control supervisors, and manufacturing foremen are direct processing costs to the extent these personnel function as first line supervisors of workers directly involved in the production operation. See HQ 554246, dated July 29, 1987. Compensation of a plant manager is generally not considered a direct cost of the processing operation, since such personnel ordinarily perform only administrative functions. However, we have held that a plant manager's compensation, including fringe benefits, is a direct cost to the extent he or she functions as a first-line production foreman. See HQ 543748, dated June 18, 1987. If the plant manager, or other administrative personnel, perform such a function, then a percentage of their salary and fringe benefits related to the performance of such functions would be a direct cost of processing operation. Id.

Compensation of maintenance personnel is a direct processing cost to the extent they maintain equipment used in the production of the subassemblies. See HQ 543748, dated June 18, 1987. Similarly, the cost of engineering personnel, including fringe benefits, is a direct cost of the processing operation if
directly incurred in the production of the specific merchandise. See 19 CFR 10.178(a)(1). Accordingly, a pro-rata portion of the compensation paid to the industrial engineer may be considered a direct processing cost to the extent his or her services relate to the subassembly production equipment or process.

Utility costs are direct processing costs to the extent actually incurred in production of the eligible article. See HQ 543748, dated June 18, 1987. Accordingly, the electricity used to operate equipment in the production of the subassemblies is a direct processing cost. A pro-rata share of the cost of electricity used for lighting the work area where the subassemblies are manufactured would be a direct cost of processing (C.S.D. 80-208, dated April 23, 1980), but the cost of electricity used for lighting or air conditioning administrative offices would not be includable.

Depreciation on machinery and equipment that is used in the production of the subassemblies is a direct processing cost. See 19 CFR 10.197(a)(2), C.S.D. 80-246, dated April 23, 1980 (HQ 542097).

The Haitian inland freight charges and brokers fees associated with the raw materials used in the production of the subassemblies are not direct processing costs, but are properly considered a cost of the raw materials. See 19 CFR 10.196(c)(1)(ii), HQ 554246, dated July 29, 1987. As stated above, costs of raw materials produced in the U.S. may be included, but in an amount not to exceed 15% of the entered value of the articles. Costs of raw materials produced in Puerto Rico may be included without limitation. Accordingly, if the broker's fees and inland freight charges relate to U.S. produced materials, they may be included as part of the material costs, subject to the 15% limitation. If such costs relate to Puerto Rican materials, they may be included as part of the materials cost without limitation. If such charges relate to materials not produced in the U.S., Puerto Rico, or other BC, they may not be included.

While casualty and liability insurance is not a direct processing cost, the costs of property insurance covering machinery and equipment used in the production process and group insurance provided to production employees as a fringe benefit are includable as direct processing costs. See HQ 543748, dated June 18, 1987. Taxes are not includable unless they meet the
criteria of 19 CFR 10.197. See HQ 056936, dated August 22, 1978 (A pro-rata share of taxes on that part of the building used in the processing operation is includable for GSP purposes.)

In C.S.D. 80-208, we stated that costs of janitorial services, to the extent incurred in the plant or factory area, were analogous to other includable items of factory overhead necessary to production, such as electricity to keep the machines running and heat to keep the workers comfortable. In the same manner, we find that the facility maintenance expenses, including compensation of maintenance personnel, are direct costs of the processing operation to the extent they relate to the plant area where the articles are produced. Those maintenance costs incurred for upkeep of administrative offices or other areas of the facility not related to the production area are not includable.

The costs of plant security, accounting personnel, office supplies, telephone and telex, and automobiles and trucks are not includable as direct processing costs. See HQ 543748, dated June 18-1987, HQ 541249, dated February 24, 1977, C.S.D. 80-208, dated March 24, 1980 (HQ 542035), and HQ 541215, dated February 25, 1977.

In sum, items 1 through 3, 5 through 9, 13, 14, 16, 17, 19, 20, and 21 are direct costs of the processing operation subject to the limitations discussed above. Items 4, 10, 11, 12, 15, 18, and 22 are not direct processing costs. Item 23, which you describe as "miscellaneous expenses," must be further described.

CONCLUSION:

The subassemblies assembled in Haiti from materials of U.S. and Puerto Rican origin will be considered products of Haiti for purposes of the CBERA. Based on the cost information provided, the 35 percent value-content requirement of the CBERA will be met. Accordingly, based on the information provided, and assuming the articles will be imported directly to the U.S., the articles will be eligible for duty-free treatment under the CBERA.

Sincerely,

John Durant, Director

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