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HQ 220968


April 8, 1991

DRA-4 CO:R:C:E 220968 GG

CATEGORY: DRAWBACK

Regional Director
Regulatory Audit
U.S. Customs Service
Southeast Region
909 S.E. First Avenue
Miami, Florida 33131-2595

RE: Substitution manufacturing drawback; 19 U.S.C. 1313(b); same kind and quality requirement; orange juice; required records

Dear Madam:

This is in response to Citrus World Inc.'s June 10, 1988, request for internal advice on issues concerning its substitution manufacturing drawback program.

FACTS:

Citrus World Incorporated ("Citrus World") is a manufacturer of citrus products. It exports some of those products and claims a duty refund under an approved 19 U.S.C. 1313(b) drawback contract, an abstract of which appears in Treasury Decision 84- 1(F). The drawback contract authorizes the substitution of domestic, duty-paid or duty-free concentrated orange juice for manufacturing (COJM) for imported COJM, and provides for the manufacture of orange juice from concentrate (reconstituted juice), frozen concentrated orange juice, and bulk concentrated orange juice, through the addition of fresh orange juice, essential oils, flavoring components, and/or water to the COJM.

In 1987, Customs audited 4 Citrus World drawback entries. The company has received $522,388.45 in accelerated payment for these claims. The audit raised several questions about the company's compliance with its contract and the drawback law and regulations. Specifically, Customs questioned whether, in using a product known as TMO during the production process, Citrus World was substituting same kind and quality merchandise. The company's practice of keeping summary, instead of batch, records also led to questions about the sufficiency of Citrus World's recordkeeping methods.

"TMO" is the name Citrus World has given to a mixture of fresh tangerine/hybrid juices and fresh orange juice that it blends and then concentrates, through evaporation, for use in manufacture. The TMO, which Citrus World stores in a tank farm, contains varying concentrations of the tangerine/hybrid juices; inventory records show that from December 1985 to April 1987, the volume of tangerine/hybrid juice in the TMO fluctuated between 16-95%. The company's drawback contract makes no provision for the infusion of tangerine or hybrid juices at any stage in the production process.

In addition to storing TMO in its tank farm, Citrus World fills its other tanks with imported USDA Grade A COJM, hybrids and other hybrid/orange juice mixtures, and domestic orange juice concentrates, which do not necessarily meet USDA Grade A quality standards for COJM. Citrus World keeps records that show the characteristics of the juices in each tank. With the assistance of computer-controlled valves, the company continuously draws various quantities of the concentrates from the tanks in the tank farm and mixes the concentrates in the pipes leading to what are known as surge tanks. Each withdrawal is identified by a sequence number; records exist that show the precise quantities of the different juices contained in each sequence. Citrus World states that the mixture in the surge tank is certifiable as USDA Grade A COJM. Except in the case where the concentrate will be used to manufacture bulk concentrated orange juice, the contents of the surge tank then are pumped into the blend tank where essential oils, water, fresh orange juice and flavoring components are added. Where bulk concentrated orange juice is being produced, the surge tank also serves as the blend tank. Periodically, drums of hybrid concentrate stored in a separate facility are added to the mixture in the reconstituted juice and frozen concentrated orange juice canning facilities; the production records do not indicate which sequences the drummed concentrates go into. The finished products are certified as meeting USDA Grade A quality standards.

ISSUE:

1) Whether Citrus World substituted same kind and quality merchandise in its production of articles later exported and claimed for drawback under 19 U.S.C. 1313(b)?;

2) Whether the company, whose operations are on a continuous basis, must keep batch instead of summary production records to identify whether qualifying articles were used in the production of articles later exported with benefit of drawback?

LAW AND ANALYSIS:

Under section 313(b) of the Tariff Act of 1930, as amended (19 U.S.C. 1313(b)) a 99% duty refund may be obtained on exported articles that were manufactured with either imported merchandise or substituted same-kind-and-quality domestic, duty-paid or duty- free merchandise, or a combination of the foregoing. Customs approved the substitution by Citrus World of domestic, duty-free or duty-paid USDA Grade A COJM for imported COJM of the same grade.

In its drawback contract, Citrus World agreed to maintain records that would show exactly what was used to produce the exported articles. To this end, it stated that its records would establish the quantity of merchandise of the same kind and quality as the designated merchandise the company used to produce the exported articles. See also 19 CFR 191.32. "Designated merchandise" in this context refers to the imported merchandise or drawback product. With the exception of concentrate added to the production process from drum storage, which will be discussed later, Citrus World's records do reflect what was used to produce the exported articles; however, the records also show that the juices the company substituted for the imported COJM were not always of the same kind and quality as the imported, designated COJM.

Citrus World has two separate storage areas where it stores various juices prior to using them to manufacture finished orange juice products: tanks in a tank farm and drums in drum storage. The company's tank farm inventory records show that the following juices are routinely stored there: TMO (a Citrus World blend of tangerine/hybrid juices (citrus reticulata) and sweet orange (citrus sinensis) concentrated for use in manufacturing); imported Brazilian COJM (BRA); early or midseason domestic COJM (EOM); mandarin/murcott concentrate (MMC); TMO OIL (TMO with orange oil added); Brazilian COJM and concentrated murcott (BRAMUR); EOM blended with murcott (EOMMUR); and EOM blended with mandarin/murcott concentrate (EOMMMC). Citrus World periodically draws varying quantities of all, or some, of these juices from the different tanks in its tank farm, and blends them together in an on-line blending system. Each withdrawal is identified by a unique sequence number. The company's tank farm activity records are detailed enough to enable the precise percentage of each type of juice in each sequence to be ascertained when it leaves the tank farm.

From the tank farm, the juices blended in each sequence flow to a surge tank. Citrus World claims that the mixture in the surge tank is certifiable as USDA Grade A COJM. Sequences containing concentrates destined for frozen concentrated orange juice or reconstituted juice production then leave the surge tank and enter a separate blend tank where the oils, fresh orange juice, water and other flavorings required to produce the exported articles are added. There is no separate blend tank for juices that are going to be manufactured into bulk concentrate; the surge tank serves as both a surge and blend tank. After leaving the blend tank, the newly-manufactured frozen concentrated orange juice and reconstituted juice go to the packing facilities, where, on occasion, drummed juices are added.

Citrus World keeps separate inventory records for juices stored in drums in drum storage; the available records indicate that some of the drums contain concentrated murcott, while others hold COJM with pulp added. There are no drum storage "activity" records to show precisely to which sequences of manufactured frozen concentrated orange juice or reconstituted juice the contents of the drums were added.

The records therefore permit, with one exception, the tracking of which juices were used to produce articles that were eventually exported. The exception is those juices that were added from drum storage. Subject to the same exception, those records also can be used to establish the quantity of merchandise of the same kind and quality as the designated merchandise that Citrus World used to produce the exported articles.

Determining which, if any, of the various stored juices were of the same kind and quality as the imported juice, is a prerequisite to establishing the exact quantity of a qualifying substitute used. Citrus World's drawback contract authorized it to substitute duty-paid, duty-free, or domestic USDA Grade A COJM for imported COJM of the same grade. However, the records indicate that not all of the juices stored in the tank farm and in drum storage fell within these specifications. For example, TMO is not of the same kind and quality as USDA Grade A COJM, because the volume of tangerine and mandarin, or reticulata, juices in this mixture of tangerine, mandarin and orange juices varied anywhere between 16-95% of the total, well above the 10% limit imposed on reticulata juices by the Food and Drug Administration (FDA) in its identity standards for COJM. 21 CFR 146.153 and 21 CFR 146.146. Treasury Decision (T.D.) 80-153 affirmed the use of these standards in determining same kind and quality questions under the substitution same condition drawback law.

Similarly, the available information suggests that the domestic orange juice concentrates (EOM) stored in the tank farm were not always of the same kind and quality as the imported merchandise. The company's contract specified that both the imported and the substituted COJM had to be of USDA Grade A quality. However, Citrus World indicates in its letter of August 21, 1990, that the domestic orange juice concentrates stored in the tank farm were not necessarily certifiable as "FCOJM". By this, we infer that Citrus World means either that the domestic orange juice concentrates did not always meet FDA identity standards for COJM, or that the concentrates did qualify as COJM, but were not of USDA Grade A quality. Citrus World would have to have records that substantiated that the domestic orange juice concentrates stored in the tank farm were of USDA Grade A quality for it to qualify as a substitute under the company's contract.

Mandarin/murcott concentrate is a hybrid, consisting predominately of reticulata juices, and as such is not of the same kind and quality as the imported designated COJM. The company concedes this point in its letter of December 29, 1989. Consequently, the drummed hybrid concentrates that Citrus World periodically added to the manufactured frozen concentrated orange juice and reconstituted juice were not qualifying substitutes under 19 U.S.C. 1313(b). Other orange juice concentrates in Citrus World's inventories that contain hybrid concentrates, e.g., EOMMUR, EOMMMC, and BRAMUR, may meet the same kind and quality requirement if the percentage of hybrid juice did not exceed 10% of the total volume and the USDA has certified that the mixtures were USDA Grade A COJM.

In conclusion, not all of the juices stored in the tank farm and in drum storage were of the same kind and quality as the imported, designated USDA Grade A COJM. The significance of this is that if the point of substitution occurred, as the auditors contend, when the juices left the tank farm and drum storage, then only those juices that were certifiable as USDA Grade A COJM while still in storage could be used as a substitute. Citrus World takes the position that substitution took place at a time when the various juices had been transformed into qualifying substitutes, namely, when the contents of the surge tanks were emptied into the blend tanks.

The company bases its argument on the fact that the mixture in the surge tanks reportedly met USDA Grade A quality standards for COJM. In Citrus World's view, the manufacture of domestic, USDA Grade A COJM, not the substitution of domestic for imported merchandise, occurred when the various juices left the tank farm and entered the pipe leading to the surge tank. That viewpoint might have had some merit had Citrus World restricted its mixing of concentrates in the pipe and surge tank to domestic orange juice concentrates, TMO, and other hybrid and hybrid/orange juice mixtures, and refrained from adding drummed hybrid concentrate in the packing facilities. In that scenario, the point of substitution - at least with respect to sequences containing concentrates destined for frozen concentrated orange juice or reconstituted juice production, where separate blend and surge tanks are used - could have been upon entry into the blend tank, where the ingredients necessary to bring about a change in the name, character, or use of the COJM were added. However, by also adding imported USDA Grade A COJM to the TMO, domestic orange juice concentrates, hybrids and hybrid/orange juice mixtures (see August 21, 1990, letter from Citrus World) Citrus World made it impossible to determine whether a mixture consisting only of TMO, domestic orange juice concentrates, hybrids and hybrid/orange juice concentrates would have met USDA Grade A quality standards for COJM. Consequently, we disagree with the position that any mixing activity prior to the blend tank involved only the production of domestic USDA Grade A COJM; rather, it involved the processing of the imported merchandise.
Except in cases where the records show that only TMO, domestic orange juice concentrates, hybrids and hybrid/orange juice mixtures were drawn from the tank farm in a particular sequence, and that no imported, designated USDA Grade A COJM was added to the sequence, and that the resulting blend met USDA Grade A quality standards for COJM, the substitution of domestic for imported concentrates commenced when the various concentrates left the tank farm and entered the pipe leading to the surge tank. Further substitution took place when drummed hybrid concentrates were periodically added in the reconstituted juice and frozen concentrated orange juice facilities.

Citrus World's tank farm inventory and activity reports conform to the requirements of both 19 CFR 191.32(a)(2) and their drawback contract, in that they contain enough information to show how much of the merchandise that left the tank farm was of the same kind and quality as the designated merchandise that was used to produce the exported articles. These records would be adequate if the tank farm were the only source of concentrate. However, the existing records are deficient because they do not show to which sequences the drummed concentrate was added. This is an important failure because the drum storage inventory records indicate that some of the drums contained hybrid concentrate which did not fall within the same kind and quality specifications. For this reason, the company in the future needs to set up a recordkeeping system that reflects precisely to which "batch" or sequence the drummed concentrate is added.

There was also a problem with the sample records submitted by Citrus World to demonstrate that the manufactured articles were exported: the invoice and bill of lading indicate that the finished product was shipped from Charleston, South Carolina, to Los Angeles, California. Regulatory Audit in Miami has stated, however, that there is sufficient proof of exportation for the merchandise covered by the drawback claims in question.

Drawback should be paid where the records show that Citrus World exported articles that were manufactured with either imported or domestic concentrates which, before leaving the tank farm, were certifiable as USDA Grade A COJM. In situations where the sequence records show that TMO or other hybrid concentrates were mixed, after leaving the tank farm, with USDA Grade A COJM, the amount to be refunded under those particular claims should be reduced by 10%. This reduction takes into account the possibility that up to 10% of the volume of the finished product may have consisted of added TMO or hybrid concentrates. Similarly, all claims covering either exported reconstituted juice or exported frozen concentrated orange juice, which may have received infusions of drummed hybrid concentrate, should be reduced by 10%, if this reduction has not already been made. (The ultimate use of the concentrates contained in each sequence is indicated on the tank farm activity report. "Send to OT08" means send to bulk concentrate production facility; "send to CONC01", to frozen concentrated orange juice facility; and "send to SS", to single strength, reconstituted juice facility.)

Customs permits substitution of same kind and quality merchandise that only meets same kind and quality criteria after it has been through some initial processing, immediately after which it is further manufactured into the final product. Therefore, if Citrus World's sequence records substantiate that domestic orange juice concentrates, TMO, and other hybrids were mixed in the pipe and surge tank, but imported, designated Grade A COJM was omitted, and the resulting mixture met USDA Grade A standards for COJM, then Customs can allow drawback on the premise that Citrus World was manufacturing domestic USDA Grade A COJM prior to substituting it for imported designated COJM of the same grade. In this situation, substitution of domestic same kind and quality merchandise, and the commencement of its processing, would have occurred in the blend tank. There should be no reduction in the refund for TMO or other hybrids added in the pipe and surge tank, because in the manufacture of USDA Grade A COJM, up to 10% of reticulata juices may legitimately be added. However, claims involving reconstituted or frozen concentrated orange juice should be reduced by 10%, to cover the eventuality that drummed hybrid concentrate was added in the packing facilities after the manufacture of the domestic USDA Grade A COJM had been completed.

Citrus World has presented two liquidation proposals which are based on the fact that there are records which establish that the exported products contained no more than 10% reticulata, or hybrid, juice. Under the first proposal, the company would deduct from its drawback claim a percentage representing reticulata juice which would reflect the ratio between the total quantity of reticulata varieties (measured in pound solids) received by Citrus World each year, and the total quantity of orange juice solids it receives in the same year. Over the past five years, this ratio reportedly has varied between 5% and 9%. Alternatively, Citrus World would agree to deduct a flat 10% from its claims. These proposals are unacceptable because, although they attempt to make adjustments for the unauthorized use of hybrids, they fail to take into account the amount of other orange juice concentrates that were substituted and were not of the same kind and quality as the imported, designated USDA Grade A COJM.

In the future, if Citrus World wants to take full advantage of the drawback program, it should structure its operations so that it either 1) makes domestic USDA Grade A COJM prior to using it to manufacture export articles in the blend tank, by restricting its mixing of concentrates in the pipe leading from the tank farm and in the surge tank to domestic orange juice concentrates, TMO and other hybrid concentrates, or 2) substitutes domestic COJM that is of proven USDA Grade A quality before it leaves the tank farm. In the latter scenario, TMO or other hybrid concentrates could not be added to the domestic USDA Grade A COJM after the domestic COJM had left the tank farm; to do so would amount to processing the COJM in a manner not authorized in the drawback contract. However, the domestic USDA Grade A COJM could be commingled with the imported, designated USDA Grade A COJM in the pipe and surge tank.

HOLDING:

1) Citrus World may have substituted same kind and quality merchandise, if the records show that the domestic, duty-paid, or duty-free concentrate it was substituting for the imported, designated USDA Grade A COJM, was USDA Grade A COJM before leaving the tank farm. TMO, hybrids, or other hybrid/orange juice concentrates added after the USDA Grade A COJM had left the tank farm, were not qualifying substitutes, and their addition, which was not authorized in Citrus World's drawback contract, must result in a 10% reduction in the company's drawback recovery.

Citrus World may also have substituted qualifying merchandise if its mixture in the pipe and surge tank consisted only of domestic, duty-paid or duty-free orange juice concentrates, TMO, hybrids, and hybrid/orange juice mixtures, and contained no imported designated merchandise, and the resulting mixture in the surge tank was certifiable as USDA Grade A COJM. A 10% reduction is not necessary in this situation.

Where imported designated USDA Grade A COJM was added to the other types of concentrates in the pipe and surge tank, then there would have been no substitution of qualifying merchandise, and drawback can only be allowed on a direct identification basis.

Drummed hybrid concentrate added in the reconstituted juice and frozen concentrated orange juice canning facilities was not a qualifying substitute. Accordingly, all claims covering these products must be reduced by 10%, if this has not already been done for the reasons described above.

2) The company must keep batch, or drum storage activity, records to identify when hybrid concentrates from drum storage were added to a particular on-line sequence.

Sincerely,

John Durant
Director, Commercial

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