HQ 0556195 - Application for Further Review of Protest No. 2704-90-004607 on the applicability of artificial flowers from Macau for duty-free treatment under the Generalized System of Preferences - United States International Trade Commision Rulings

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HQ 556195

December 17, 1992

CLA-2 CO:R:C:S 556195 WAW

CATEGORY: CLASSIFICATION

District Director
U.S. Customs Service
Air Transportation Division
5758 West Century Blvd.
Los Angeles International Airport
Los Angeles, CA 90045

RE: Application for Further Review of Protest No. 2704-90-004607 on the applicability of artificial flowers from Macau for duty-free treatment under the Generalized System of Preferences

Dear Sir:

The above-referenced protest was forwarded to this office for further review. The protestant, Celebrity, Inc., contests the denial of duty-free treatment for artificial flowers from Macau under the Generalized System of Preferences (GSP) (19 U.S.C. 2461- 2466). The two entries of artificial flowers covered by this protest are dated July 13, and September 10, 1990. We had an opportunity to meet with representatives from Givens & Kelly, on behalf of Celebrity, Inc., on December 18, 1991, in connection with this matter. In addition, all other reports, auditor-prepared studies, photographs, depositions, affidavits, documents, and letters dated March 6, August 27, August 28, September 29, 1992, which counsel submitted subsequent to the meeting were considered in rendering our final decision.

FACTS:

The merchandise at issue in this protest consists of artificial flowers and foliage of polyester material. The protestant contends that Customs has erroneously classified the artificial flowers under subheading 6702.90.4001, Harmonized Tariff Schedule of the United States Annotated (HTSUSA), which provides for artificial flowers of man-made fibers, under the general rate of 9 percent ad valorem which is the applicable duty rate for products from the Peoples' Republic of China (PRC). The protestant claims that the artificial flowers should be classified under subheading A 6702.90.4001, HTSUSA, at the special duty-free rate for products of Macau under the GSP.

By memorandum to the field dated January 22, 1991 (INV 8-02 CO:T:O:C RG), the Assistant Commissioner for Commercial Operations instructed the Regional Commissioners that entries of artificial flowers claimed to be manufactured in Macau by certain factories should be denied GSP treatment and rate advanced via the issuance of a Proposed Notice of Action (CF 29). The Macau factories involved in this protest, "Tai Keong" and "Golden Dragon," are two of the factories which were precluded from receiving duty-free treatment under the GSP pursuant to these instructions. Furthermore, the Assistant Commissioner's memorandum stated that the Senior Customs Representative, Hong Kong (SCR/HK) issued reports of investigation concerning the alleged transshipments of PRC-origin artificial flowers via Macau, which indicated that the named factories were either "not manufacturing artificial flowers in Macau, or were incapable of manufacturing them in the quantities exported to the U.S." Therefore, the Assistant Commissioner stated that in the absence of "compelling evidence" to the contrary, protests filed on the liquidation of entries from any of the named factories should be denied.

In support of the GSP claims for the subject entries, the protestant claims that the raw materials imported into Macau were transformed by means of substantial processing (i.e., the combination of cutting, dyeing, pressing, heating and molding) into new and different articles of commerce. The protestant states that the flower and foliage components which resulted from the manufacturing processes in Macau were significantly different in terms of name, character and use from the undyed fabric, plastic, and uncut wire initially imported into the country.

Further information was submitted by the protestant in the form of an audit report prepared by "Deloitte Ross Tohmatsu" of Hong Kong. The following was reported regarding the production processes by the Great Strong factory ("Tai Keong"). Fabric was imported into Macau from Hong Kong in 500 bolt bundles. Once at the factory in Macau, the fabric was folded and then die cut into shapes suitable for use as individual flower components by means of cutting presses. Dyeing operations were performed by the use of convection and microwave drying ovens, centrifugal dye spinners, numerous small dyeing vats, dyes, paints, bleaches, solvents and other dyeing chemicals. The polyester fabric was then pressed into leaves and petals for the flower by heat molding machines. Plastic (polyethylene) pieces from Hong Kong were delivered to the Diamond factory, which was related to the Great Strong factory and was also located in Macau, where the artificial flowers were molded by means of plastic injection molding machines. The finished parts were transferred back to the Great Strong factory pending delivery to the PRC for assembly. Finally, after assembly in the PRC, the finished goods were returned to Macau where they underwent packaging, quality control, and labeling operations before they were shipped to the U.S.

In another audit report prepared by "Deloitte Ross Tohmatsu" of Hong Kong, the following information was reported on the production processes at the Golden Dragon factory in Macau. The Golden Dragon factory purchased its raw materials from foreign suppliers. The raw materials required for the manufacturing process consisted mainly of polyester fabrics, polyethylene, and metal wire. The polyester and polyethylene were purchased from Taiwan and Japan, respectively, through Hong Kong agents, while the metal wire was purchased from Hong Kong manufacturers. The Macau factory was responsible for molding, cutting, dyeing, and shaping of the individual pieces, as well as administration and packaging, and employed approximately 90 workers to perform these functions. After all of the parts of the flower were manufactured, they were transferred to mainland China for assembly operations. The finished goods were then exported back to Macau for final packaging and quality control. The final products were stored in the packaging factory in Macau prior to shipment to the U.S.

To further document Golden Dragon's manufacturing operations in Macau during the period of the protest, protestant submitted two depositions. The depositions taken include those of Simon Tse, former manager of the Golden Dragon factory in Macau, which was the major Macau supplier of Celebrity and Elena Belgrado of Celebrity Exports International in Hong Kong.

In his deposition, Mr. Tse stated that the Golden Dragon factory performed cutting, plastic injection, molding and dyeing operations to produce artificial flowers at two of its facilities in Macau. He also confirmed that some assembly operations were performed on the subject flowers in China; however, he claimed that the Chinese input constituted approximately 3-5% of the cost of the flowers; In another deposition dated September 17, 1992, Mr. Tse provided production costs arising and originating in Macau respecting the artificial flowers shipped to Celebrity under entries #153-0100123-4 and #153-0100214-1.

Elena Belgrado stated in her deposition that she had also visited the Golden Dragon factory in Macau and observed the artificial flower production there, which included molding, dyeing, and other related operations.

The protestant maintains that at least 35% of the appraised value of the flowers/foliage here at issue is attributable to the cost of domestic materials plus the direct costs of processing operations performed in Macau. In support of its contention, the protestant has provided Form A's with the accompanying shipments, as well as affidavits from factory representatives, which indicate that these articles were produced in Macau. In addition, each Form A states that the cost of the domestic materials, plus the direct costs of processing operations in Macau equals at least 35% of the "ex-factory price" of the articles. Therefore, the protestant claims that this evidence is sufficient to satisfy the 35% value- added criteria of the GSP.

With regard to the assembly process performed in the PRC, the protestant claims that the assembly of the flowers, stems and leaves was a simple operation which merely consisted of attaching pre-assembled components together and did not constitute a subsequent substantial transformation of the flower components into "products of" the PRC. The protestant stated at the December 18th meeting that the assembly process represented approximately 3-5% of the appraised value of the artificial flowers. Furthermore, the protestant submits that although the goods at issue were shipped to the PRC for assembly operations, they were ultimately returned to Macau for final inspection, packaging, and labeling before being shipped to the U.S., and, therefore, the goods should be considered "imported directly" from Macau for purposes of the GSP. Accordingly, the protestant claims that the subject merchandise should be entitled to duty-free treatment under the GSP.

Finally, the protestant argues that, in the alternative to the foregoing, the doctrine of detrimental reliance should be applicable to the entries involved in this protest. The protestant states that following Celebrity's commencement of purchases of artificial flowers from Macau in 1985, they consistently received with each shipment from Macau a Form A, wherein the government of Macau certified that the flowers shipped to the U.S. were in fact products of Macau. Furthermore, the protestant claims that these Form A's were presented to Customs for inspection and accepted without question up until September of 1990, when Customs seized Celebrity's artificial flower inventory and began detaining its incoming shipments from Macau. The protestant notes that as soon as it discovered that Customs was questioning the validity of the country of origin of the artificial flowers from Macau, it ceased purchasing artificial flowers from Macau.

ISSUE:

Whether the artificial flowers from Macau are eligible for duty-free treatment under the GSP.

LAW AND ANALYSIS:

Under the GSP, eligible articles the growth, product or manufacture of a designated beneficiary developing country (BDC) which are imported directly into the customs territory of the U.S. from a BDC may receive duty-free treatment if the sum of (1) the cost or value of materials produced in the BDC, plus (2) the direct costs of the processing operations in the BDC, is equivalent to at least 35% of the appraised value of the article at the time of entry. See 19 U.S.C. 2463(b).

The 35% value-content and "imported directly" requirements of 19 U.S.C. 2463(b) were conceived as separate and distinct country of origin tests designed to ensure that the benefits of the duty- free program actually accrue to the countries for which they were intended. See The Trade Act of 1973: Hearings on H.R. 10710 Before the Senate Committee on Finance, 93rd Cong., 2nd Sess. 326 (1974) (statement of William D. Eberle, U.S. Special Representative for Trade Negotiations). This goal is accomplished by limiting the opportunities during which non-eligible goods may be commingled with eligible goods. The importer must satisfy both requirements in order to receive duty-free treatment of its merchandise.

In Madison Galleries, Ltd. v. United States, 688 F. Supp. 1544 (CIT 1988), aff'd, 870 F.2d 627 (Fed. Cir. 1989), the court concluded that, under the GSP statute, it is unnecessary for an article to be a "product of" a GSP country to be eligible for duty- free treatment under that program. However, section 226 of the Customs and Trade Act of 1990, includes an amendment to the GSP statute requiring articles entered on or after August 20, 1990, to be a "product of" a BDC to receive duty-free treatment. Therefore, artificial flower shipments from Macau which were entered on or after August 20, 1990, must also satisfy the "product of" requirement.

Macau is a BDC. See General Note 3(c)(ii)(A), Harmonized Tariff Schedule of the United States Annotated (HTSUSA). Based upon the information provided, the artificial flowers are classified in Heading 6702, HTSUSA, which provides for "[a]rtificial flowers, foliage and fruit and parts thereof; articles made of artificial flowers, foliage or fruit." Every subheading under Heading 6702, HTSUSA, is a GSP-eligible provision. Accordingly, the subject artificial flowers may be eligible for duty-free treatment under the GSP, if they are considered to be "products of" Macau (entry dated September 10, 1990 only), the 35% value-content minimum is met, and they were "imported directly" into the U.S.

If an article is produced or assembled from materials which are imported into the BDC, the article is considered to be a "product of" the BDC only if the processing performed there results in a substantial transformation of the imported materials. The courts have stated that 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." Texas Instruments Inc. v. United States, 69 CCPA 152, 156, 681 F.2d 778, 782 (1982).

The first question presented in determining whether the artificial flowers are "products of" Macau, is whether die cutting the imported cloth in Macau into desired patterns for use as artificial flower parts constitutes a substantial transformation. Customs has held under certain circumstances that the cutting of fabric into specific patterns and shapes suitable for use to form the completed article constitutes a substantial transformation. See Headquarters Ruling Letter (HRL) 731028 dated July 18, 1988 (cutting of fabric into garment parts for wearing apparel constitutes a substantial transformation), and HRL 555693 dated April 15, 1991 (cutting of fabric to create pattern pieces for infant carrier results in a substantial transformation).

In this case, based on the information provided, we find that the die cutting of fabric for artificial flowers in Macau is analogous to the cutting of garment parts for wearing apparel. The cloth in the instant case is cut into individual flower components (e.g., leaves, petals) which, when assembled with other components, create the finished artificial flower. Therefore, we find that the cutting to shape of the imported cloth substantially transforms the material into a new and different article of commerce.

Furthermore, with regard to the injection molding process performed in Macau, Customs has consistently held that products created by a thermal injection molding process have undergone a substantial transformation. See HRL 071518 dated November 8, 1984; 071534 dated July 19, 1984; HRL 555659 dated December 3, 1990 (molded plastic parts, such as handles, folding hinges, brakes, and folding clip are different articles from the resins from which they are made). In the instant case, it is clear that the plastic pellets imported into Macau in connection with the production of the flowers and foliage, where they underwent a thermal injection molding process to create stems and other plastic parts were substantially transformed into new and different articles of commerce. Therefore, at this stage in the production process, the fabric and plastic flower components are considered "products of" Macau.

We believe that the assembly of these flower components in the PRC, which consisted of snapping the pre-assembled components together, was far too minor a procedure to constitute a substantial transformation of the components into "products of" the PRC. The flowers, stems and leaves were clearly recognizable as completed components prior to importation to the PRC and already possessed the essential character of flowers as a result of the manufacturing processes in Macau. Thus, the simple assembly process which occurred in the PRC did not change the flower components into "products of" the PRC.

We have previously held that the "imported directly" requirement is not met where a product of a BDC is further processed in a non-BDC and then merely transshipped through the territory of the BDC without entering into the commerce of the BDC. See HRL 555398 dated December 12, 1989. For instance, we held in HRL 554027 dated January 13, 1987, that merchandise which is manufactured in the Virgin Islands and shipped to the Dominican Republic for certain assembly operations after which it was returned to the Virgin Islands for shipment to the U.S. constitutes a direct shipment, given that the merchandise ultimately traveled directly from the insular possession to the U.S. In the instant case, based upon HRL 554027, the transfer of the artificial flower components to the PRC for assembly and the subsequent return of the flowers to Macau for packaging as well as labeling operations before shipment to the U.S., satisfies the "imported directly" requirement for purposes of the GSP.

In addition to the "imported directly" and "product of" requirements, to be eligible for duty-free treatment under the GSP statute, merchandise must also satisfy a 35% value-content requirement. If an article consists of materials which are imported into a BDC, as in the instant case, the cost or value of these materials may be counted toward the 35% value-content requirement only if they undergo a double substantial transformation in the BDC. In other words, the cost or value of imported materials used to produce an article may be included in the GSP 35% value-content computation only if they are first substantially transformed in a BDC into a new and different article of commerce, which is itself substantially transformed in the BDC into the final article. In the instant case, this means that foreign-origin materials, such as the fabric imported into Macau, must have been substantially transformed in Macau into a new and different article of commerce, which itself was substantially transformed into yet another new and different article, while still in Macau.

In Uniroyal, Inc. v. United States, 3 CIT 220, 542 F. Supp. 1026 (1982), a country of origin marking case involving imported shoe uppers, the court considered whether the addition of an outsole in the U.S. to imported uppers lasted in Indonesia effects a substantial transformation of the uppers. The court described the imported upper, which resembled a moccasin, and the process of attaching the outsole to the upper. The factors the court examined to determine whether a substantial transformation had taken place included: (a) a comparison of the time involved in attaching the outsole versus the time involved in manufacturing the upper, (b) a comparison of the cost involved in the process of attaching the outsole versus the cost involved in the process of manufacturing the upper, (c) a comparison of the cost of the imported upper versus the cost of outsole, and (d) a comparison of the number of highly skilled operations involved in both processes. The court concluded that a substantial transformation of the upper had not occurred since the attachment of the outsole to the upper is a minor manufacturing or combining process which leaves the identity of the upper intact. The upper was described as a substantially complete shoe and the manufacturing process taking place in the U.S. required only a small fraction of the time and cost involved in producing the upper.

Furthermore, in Uniroyal, the court examined the facts presented and determined that the completed upper was the very essence of the completed shoe. The concept of the "very essence" of a product was applied in National Juice Products v. United States, 628 F. Supp. 978, 10 CIT 48 (CIT 1986), where the court determined that imported frozen concentrated orange juice was not substantially transformed in the U.S. when it was domestically processed into retail orange juice products. The court agreed with Customs that the orange juice concentrate "imparts the essential character to the juice and makes it orange juice . . . thus, as in Uniroyal, the imported product is the very essence of the retail product."

It is our opinion that the texturizing process, which involved the application of heat and pressure, in Macau did not constitute a second substantial transformation of the imported fabric. Consistent with Uniroyal, it is our determination that the very essence of the final product in the instant case was imparted by the dye cutting of the fabric into shapes of flower components, prior to the additional operations performed in Macau. The retail product in this case was the artificial flowers which were comprised of the leaves and flowers with the stems attached. The texturizing process which involved molding the plastic veins to the leaf and flower components did not change the fundamental character of the leaves and flowers. Before the components underwent the texturizing process, they were dedicated to a singular use as leaves and flowers for artificial flowers and the components already possessed the essential character of artificial flowers. It was only after the cutting operations that the cut and dyed cloth adopted the characteristics of a flower. The cut and dyed fabric had already been formed into a leaf or flower at this stage of production and the addition of the texturizing did not alter the essential character of the components. We view the texturizing process as merely a finishing process which did not constitute a second substantial transformation of the cut fabric and molded plastic components into new and different articles with a new name, character or use.

In regard to the 35% value-content requirement, we do not believe that the combination of die cutting, dyeing and texturizing (heating and molding) of the foreign-origin fabric in Macau resulted in a double substantial transformation of the material. Therefore, the cost or value of the fabric may not be included in the 35% value-content calculation. Likewise, we do not find that the plastic materials underwent a double substantial transformation, for purposes of allowing the cost or value of the plastic to be included toward the GSP 35% requirement.

Under the circumstances in this case, the 35% value-content requirement must be satisfied by calculating the "direct costs of processing operations" performed in Macau alone. Direct costs of processing operations include 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 in Macau. See section 10.197, Customs Regulations (19 CFR 10.197(a)).

In response to our initial request for verification of the production cost data for the factories at issue in this protest, counsel provided an affidavit dated January 30, 1992, of Simon Tse, manager of the Tung Nam artificial flower factory located in Jiangmaen China, and an affidavit dated January 16, 1992, of Richard Yuen, managing director of Celebrity Exports International Limited. Simon Tse provided factory cost data for the Tung Nam factory involved in producing various styles of artificial flowers and foliage, including raw material costs, labor costs and overhead costs. The affidavit of Richard Yuen also set forth data as to the labor, raw materials and overhead costs which were incurred in the production of various different styles of flowers and foliage by two factories located in China (Tung Nam and Good Ocean) as well as by the Great Strong factory which was operating in Macau. At the time of these submissions, we did not receive any cost information in connection with the Golden Dragon factory.

For purposes of determining whether the 35% value-content requirement is satisfied for the merchandise at issue, however, only the direct processing costs incurred for that merchandise may be counted. Direct processing costs incurred in factories other than that in which the instant merchandise was processed are clearly not includable. Therefore, we found that the direct processing costs for the Tung Nam and Good Ocean factories which are located in China were not instructive in determining whether the 35% value-content requirement is satisfied in the instant case.

We again requested specific information regarding the actual costs of processing operations for each entry covered under the subject protest or the total cost of processing operations upon which the percentages protestant had previously submitted were based. In response to our request, counsel provided two additional affidavits dated August 25, and September 17, 1992, signed by Simon Tse, which contain a breakdown of the per-unit processing and material costs involved in the production of the artificial flowers involved in this protest. Separate breakdowns were provided for the different style categories of artificial flowers covered by the subject entries. We are satisfied by these submissions that the direct costs of processing represented at least 35% of the appraised value for the subject entries.

We calculated the direct costs of processing elements of the value-content requirement as follows: First, in calculating the allowable elements of the direct costs of processing for the Great Strong and Tai Keong factories, we omitted the value of the plastic, polyester, steel, and miscellaneous materials, included as part of the raw materials which were identified in the cost submissions, since these foreign materials did not undergo the requisite double substantial transformation to be allowable in the 35% value-content calculation. Of the remaining costs, we included the labor costs attributable to the molding of the plastic, cutting, dyeing, heat molding, and packaging operations, since all of these costs are directly related to the production of the subject artificial flowers. In addition to the labor costs, we also included the value of the rent and utilities which were directly attributable to the production of the artificial flowers. We, however, did not include any of the costs attributable to the assembly of the flowers toward the direct costs of processing. Protestant has conceded that the assembly of the artificial flowers occurred in the PRC, and pursuant to the GSP, the value of work performed outside of a BDC may not be included toward the 35% value-content requirement. We also omitted the costs attributable to sales/management, profit and miscellaneous overhead expenses, since these costs are not considered to be allowable elements of direct costs of processing. See 19 CFR 10.197.

To arrive at a percentage of the direct costs of processing as compared to the appraised value of the artificial flowers, we first added the costs of the manufacturing operations which took place in Macau (i.e., die cutting, dyeing, plastic molding, heat molding, and packaging), the value of the materials produced in Macau (i.e., corrugated box - See C.S.D. 79-199, 13 Cust. Bull. 1270 (1978)), and the value for the portion of the rent and utilities attributable to the manufacture of the flowers. Finally, we divided the resulting number by the full appraised value of the merchandise.

Based on our calculations of the cost figures submitted on behalf of the "Golden Dragon" and "Tai Keong" factories, we have determined that the direct costs of processing operations in Macau for the artificial flowers subject to this protest represent at least 35% of the appraised value of the subject merchandise. Therefore, the merchandise is eligible for duty-free entry into the U.S. pursuant to the GSP.
HOLDING:

Upon review of all of the documentary evidence submitted in connection with this protest, which contests the assessment of duties on entries of artificial flowers from Macau, it is our determination that the combination of cutting, dyeing, pressing, heating and molding of the foreign-origin materials (fabric, polyetheylene and metal wire) into artificial flowers did not constitute a double substantial transformation of these materials. Therefore, the cost or value of these materials may not be included in the GSP 35% value-content requirement. However, based on the production cost data submitted by protestant, as the direct costs of processing operations represent at least 35% of the appraised value of the merchandise, the artificial flowers are eligible for duty-free treatment under the GSP.

Based on the foregoing discussion, this protest should be granted in full. A copy of this decision should be attached to Customs Form 19 and mailed to the protestant as part of the notice of action on the protest.

Sincerely,

John Durant, Director

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