HQ 0089427 - CFTA; direct cost of processing; costs directly incurred in the production of goods; reasonably allocated; including; originating good; General Note 3(c)(vii)(O) - United States International Trade Commision Rulings

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HQ 089427

December 9, 1991

CLA-2 CO:R:C:M 089427 JLV

CATEGORY: CLASSIFICATION

Director
Office of Regulatory Audit
U.S. Customs Service
1301 Constitution Avenue, NW
Washington, D.C. 20229

RE: CFTA; direct cost of processing; costs directly incurred in the production of goods; reasonably allocated; including; originating good; General Note 3(c)(vii)(O)

Dear Mr. Inch:

In a memorandum of May 29, 1991, you requested internal advice on the interpretation of certain terms used in the definition for direct cost of processing, Article 304, United States-Canada Free-Trade Agreement (CFTA), approved and implemented in Section 202(f)(3) of the United States-Canada Free-Trade Agreement Implementation Act of 1988, Public Law 100- 449, 102 Stat. 1859, set forth at General Note 3(c)(vii)((O), Harmonized Tariff Schedule of the United States (HTSUS), 19 U.S.C. 1202. Our decision follows.

FACTS:

Under certain rules of origin in the CFTA, a value-content requirement must be satisfied before goods will qualify as originating goods for duty preferences. This requirement or test is a ratio of the "value of materials originating in the territory of Canada and/or the United States plus the direct cost of processing performed in the territory of Canada and/or the United States" to the value of the goods when exported to the territory of the United States. This ratio is expressed as a percentage. General Note 3(c)(vii)(M) defines the value of originating materials. General Note 3(c)(vii)(O) defines direct cost of processing.

In reviewing certain costs during audits performed on entries and claims made under the CFTA, you have encountered conflicting interpretations of the terms used in the definition
of "direct cost." The definition consists of two parts, a statement as to the nature of the costs which are included and a list of specific costs that are either included or not included. Specifically, you have encountered problems with these terms: directly incurred in, reasonably be allocated to, production of goods, and including, which are terms in the first part of the definition.

ISSUE:

What is meant by the phrases "directly incurred in * * * the production of goods," "or that can reasonably be allocated to * * * the production of goods," "the production of goods," and "including," for purposes of the definition of direct cost of processing or direct cost of assembling in General Note

LAW AND ANALYSIS:

General Note 3(c)(vii)(O) states the following:

3. Rates of Duty.

(c) Products Eligible for Special Tariff Treatment.

(vii) United States-Canada Free-Trade
Agreement Implementation Act of 1988.

(O) As used in subdivisions (c)(vii)(H), (N) and (R) of this note, the phrase "direct cost of processing or direct cost of assembling" means the costs directly incurred in, or that can reasonably be allocated to, the production of goods, including--

The definition for direct cost must be read as a whole in order to give full effect to all the terms. Therefore, our interpretation of this definition must also consider the extensive list of costs which are numbered (1) through (6) in General Note 3(c)(vii)(O), HTSUS. Because of the length of the list, it is not repeated in the text of this ruling.

The phrase directly incurred in * * * the production of goods establishes the fundamental concept as to the nature of the costs that constitute the "direct cost of processing." "Directly incurred in" is taken to mean "stemming immediately from" or "having a close causal relationship to" the production of the goods. This is taken from the ordinary, common meanings of the terms "directly" and "incurred" that are used in this phrase. Webster's Third New International Dictionary, (1965), pages 621 and 1146. "Production" is the act of bringing forth or making. The act of making refers to the actual physical process, involving effort or work supplied by labor or equipment, by which an article is made. Therefore, the phrase provides a narrow definition for direct costs as costs which are the necessary costs incurred as the result of, or which stem immediately from, the physical process of making an article.

The narrow meaning of this phrase, derived from the common meanings of the terms in the phrase, is supported in principle by the following list of costs that are identified as included or not included as costs directly incurred in the production of goods. The included costs, such as all labor, inspection, testing, energy, depreciation on machinery, and development and design, are costs which stem from the physical development and processing that results in a product. The costs that are not included, such as general expense of doing business, costs of administrative functions, profit, and costs related to the sale of the goods, although related to the goods, have no direct relationship to the physical making or processing of a product. Therefore, the costs directly incurred in the production of goods are only those costs which are necessary and related to the physical development and processing of the goods.

The phrase or can reasonably be allocated to * * * the production of goods must be read in light of our interpretation of the preceding phrase. This phrase does not expand the nature of the costs that can be included to those costs which are not direct. Rather, it provides for the inclusion of certain costs in situations in which (1) the costs are directly incurred in the production of goods but may apply to two or more different products produced in the same facility, or (2) the costs consist of both included and excluded cost elements, or (3) the costs may have been incurred in a prior production period but which can be matched with the current production period. In any of these situations, the costs are "directly incurred in the production of goods" but must be prorated or otherwise allocated in order to identify only the direct cost that relates to the specific goods in question.

Finally, the term including, as used in this CFTA definition, is an introductory term prior to the enumeration of costs that are considered to be direct costs. However, it does not introduce an exhaustive list of direct costs. If the term "including" were meant to be inclusive of all costs considered to be "directly incurred" in the production, then it would have been superfluous to add, as has been done, a list of costs which are not included. It can be presumed that statutory provisions do not contain superfluous language.

HOLDING:

The direct cost of processing or direct cost of assembly in General Note 3(c)(vii)(O) means those costs which are the necessary costs incurred as the result of, or which stem immediately from, the physical process by which the article is made. To the extent that certain costs may include both direct costs and other costs, the direct costs may be included as a direct cost of processing if they can be reasonably allocated to the production of the article.

The term "including" illustrates those costs, and like costs, which are a direct cost of processing. Similarly, the phrase "not including" illustrates those costs, and like costs, which are not a direct cost of processing for purposes of General Note 3(c)(vii)(O), HTSUS.

Sincerely,

Harvey Fox

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