HQ 0556224 - Application for Further Review of Protest No. 2704-01-101622 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 556224

September 8, 1992

CLA-2 CO:R:C:S 556224 WAW

CATEGORY: CLASSIFICATION

District Director
U.S. Customs Service
Los Angeles, CA

RE: Application for Further Review of Protest No. 2704-01-101622 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, K Mart, 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 entries of artificial flowers covered during the period of this protest were dated February 9, July 13, July 18, July 25, and August 29, 1990. We had an opportunity to meet with representatives from Sharretts, Paley, Carter & Blauvelt, P.C., on behalf of K Mart, on December 18, 1991, in connection with this matter. In addition, all other reports, auditor-prepared studies, photographs, depositions, affidavits, and documents, 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 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, "Hip Wai" 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/Hong Kong) 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 stated 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 documents were provided regarding the production processes by the "Hip Wai" factory. These documents included (1) purchase invoices for fabric, plastic resin, metal wire; (2) production statistics schedules for cutting, dyeing and shaping operations; (3) monthly employers records for the period covering the protest; (4) export and import declarations for stocks delivered into China and back to Macau; and (5) records of wages paid for subcontracting work (assembly) performed in China for the period of February to September 1990.

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, which were delivered to the factory in Macau. 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, shaping of the individual pieces, 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. Upon receipt of the artificial flower parts in the PRC, a physical inventory was taken to confirm the quantities of all of the individual parts listed on the required documents. The parts were then "farmed out" to small groups for assembly, i.e., inserting leaves on stems, stems on bases, flowers on stems. All of the assembled products were sorted, in some cases price tickets were affixed, and the flowers were packed in export cartons for return to Macau. In Macau, the documents were checked against the original temporary export declaration, random physical checks of the products were conducted by Macau Customs and the Macau Marine police. The cargo was then released to the originating factory in Macau as soon as all of the shipping documents were in order. Upon receipt in the factory, the finished goods underwent final packaging and quality control. The 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 depositions taken from the following three persons: Simon Tse, manager of the Golden Dragon factory in Macau, which was the major Macau supplier of Celebrity, Elena Belgrado of Celebrity Exports International in Hong Kong, and Robert E. Armstrong, senior buyer of the Horticulture Department for the K Mart Corporation. 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. Ms. Belgrado stated in her deposition that she also had visited the Golden Dragon factory in Macau and observed the artificial flower production there which included the molding, dyeing, as well as other related operations. In his deposition, Mr. Armstrong stated that he had personally visited the Golden Dragon factory and observed the stamping, shaping, dyeing, packing, and tagging of the flowers. He also stated that during his visit to the factory he observed approximately 60 or 70 employees working in the Macau factory.

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 equal 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 during 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 satisfies all of the requirements of the GSP and should be entitled to duty-free treatment under this program.

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 K Mart'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 incoming shipments of artificial flowers 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 August 29, 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 cost or value of those materials may be counted toward the 35% value-content requirement only if they undergo a double substantial transformation in the BDC. See section 10.177, Customs Regulations (19 CFR 10.177), and Azteca Milling Co. v. United States, 703 F. Supp. 949 (CIT 1988), aff'd, 890 F.2d 1150 (Fed. Cir. 1989). That is, the cost or value of the imported materials used to produce the artificial flowers may be included in the GSP 35% value-content computation only if they were first substantially transformed in Macau into a new and different article of commerce, which itself was substantially transformed in Macau into the final article.

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) 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 new and different articles 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 together pre-assembled components, 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. We have previously 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, although the artificial flowers were sent to the PRC for assembly, the subsequent reexportation of the flowers to Macau for packaging as well as labeling operations before shipment to the U.S., satisfied 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.

For puposes of considering whether these articles were further substantially transformed in Macau, we find relevant, the case of Uniroyal, Inc. v. United States, 3 CIT 220, 542 F. Supp. 1026 (1982), a country of origin marking case involving imported shoe uppers. In this case, the court considered whether the addition of an outsole in the U.S. to imported uppers lasted in Indonesia effected 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 of Simon Tse, manager of the Tung Nam artificial flower factory located in Jiangmaen China, and 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 sets 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. The cost data supplied for the Great Strong factory was only a general percentage breakdown of the costs involved in the manufacture of artificial flowers, and did not represent the actual costs of processing for each specific entry covered under this protest.

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 find that the direct processing costs for the Tung Nam and Good Ocean factories which are located in China and the direct processing costs for Great Strong, a Macau factory which was not the producer of the goods covered by the subject protest, do not constitute probative evidence of whether the 35% value-content requirement is satisfied in the instant case.

By letter dated June 12, 1992, 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 you previously submitted were based. Counsel has been unable to provide this information.

The Customs Regulations require that a protest set forth the nature of, and justification for the objection set forth distinctly and specifically with respect to each claim. Section 174.13(a)(6), Customs Regulations (19 CFR 174.13(a)(6)). The Customs Service has and will continue to fully consider any relevant allegation in a protest supported by competent evidence. However, in acting on a protest, Customs cannot and will not assume facts that are not presented (e.g., an unsubstantiated claim that the direct costs of processing operations incurred in producing the artificial flowers was equivalent to at least 35% of the appraised value of the merchandise). Accordingly, without sufficient information regarding the costs of producing artificial flowers in both the Hip Wai and Golden Dragon factories, we cannot determine whether the GSP 35% value-content minimum would be satisfied in the instant case.

In sum, we are of the opinion that the protestant has not submitted sufficient independent evidence in support of its contention that the artificial flowers produced in these factories should be granted duty-free treatment under the GSP. Protestant simply asserts that the importer relied on the supplier's representations that the merchandise was manufactured in Macau. We note that the production data and other documents included in the auditor's report which were submitted on behalf of these factories, were not accompanied by affidavits or depositions which attested to the validity of these shipping documents. Moreover, during Customs' investigation of the Hip Wai factory, the evidence indicated that artificial flowers imported by this factory were neither produced by Hip Wai in their factory in Macau, nor assembled in the PRC from components produced by Hip Wai. As to the Golden Dragon factory, while it was reported that Golden Dragon exhibited a viable production capability to manufacture artificial flowers on their premises, the investigation also revealed that the factory had instead chosen to produce a portion or all of their components in the PRC. Under the foregoing circumstances, we cannot conclude that the GSP Form A's and declarations represent compelling evidence of eligibility for duty-free treatment for the subject entries.

The protestant also believes that, as an alternative matter, the doctrine of detrimental reliance is applicable to this protest. According to the Customs Regulations, detrimental reliance may be granted to a person who can demonstrate a reasonable reliance upon either a ruling letter or "treatment previously accorded by Customs to substantially identical transactions" over a period of at least two years. See 19 CFR 177.9. In this case, the protestant never received a ruling which stated that the subject artificial flowers were entitled to duty-free treatment under the GSP. Moreover, the protestant has not demonstrated that "substantially identical" transactions were involved in the entries accepted by Customs as GSP duty-free over a period of at least two years prior to the protested entries. Based upon the entry documentation submitted for the current protested entries, it is likely that any prior entries covering substantially identical GSP claims by the protestant included misleading descriptions of the processes performed abroad on the "Multiple Country Declaration." For instance, contrary to protestant's statements, the assembly of the flowers was described on the protested entries as having been performed in Macau. An importer cannot be deemed to have reasonably relied upon Customs treatment of prior entries which did not properly reflect the true circumstances regarding the merchandise. Therefore, for all of the reasons stated above, we find that the protestant's claim of detrimental reliance is not substantiated.

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 the Golden Dragon and Hip Wai factories in Macau, it is our determination that the combination of cutting, dyeing, pressing, heating and molding of the foreign-origin materials (fabric, polyethylene and metal wire) into artificial flowers does not constitute a double substantial transformation of these materials. Therefore, the cost or value of these materials cannot be included in the GSP 35% value-content requirement. Moreover, as we have insufficient evidence to support a finding that the direct costs of processing operations are equal to at least 35% of the appraised value of the merchandise, the artificial flowers are not eligible for duty-free treatment under the GSP.

Based on the foregoing discussion, this protest should be denied 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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