HQ 0556226 - VHS cassettes created by duplicating master tapes onto blank magnetic tape rolls and loading the duplicated tape into an empty VHS cassette case; CBI; U.S. Note 2(b); 555778 - United States International Trade Commision Rulings

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HQ 556226

December 27, 1991
CLA-2 CO:R:C:S 556226 SER

CATEGORY: CLASSIFICATION

Mr. Tony Dragan
TVTEC
Brievengat Industrial Park
P.O. Box 6024
ITC Building
Curacao, The Netherlands Antilles

RE: VHS cassettes created by duplicating master tapes onto blank magnetic tape rolls and loading the duplicated tape into an empty VHS cassette case; CBI; U.S. Note 2(b); 555778

Dear Mr. Dragan:

This is in reference to your letter received August 19, 1991, requesting a ruling concerning the eligibility for duty- free treatment of pre-recorded videocassettes under U.S. Note 2(b), subchapter II, Chapter 98, Harmonized Tariff Schedule of the United States Annotated (HTSUSA), and the Caribbean Basin Initiative (CBI)(19 USC 2701-2706). You reference an earlier Customs ruling, Headquarters Ruling Letter (HRL) 555778 dated February 15, 1991, issued on the same subject matter.

FACTS:

Based on the supplied information, a video cassette duplication facility has been established in Curacao, the Netherlands Antilles. Magnetic tape roll is imported into the Netherlands Antilles from Japan for use in producing the pre- recorded tapes, made from a master tape on a high-speed duplicator machine. All other materials are stated to be imported from the U.S.

ISSUES:

1. Whether the pre-recorded video cassettes are entitled to duty-free treatment under U.S. Note 2(b), subchapter II, Chapter 98, HTSUSA.

2. Whether the tapes are eligible for duty-free treatment under the CBI when imported into the U.S.

LAW AND ANALYSIS:

1. Eligibility under U.S. Note 2(b), subchapter II, Chapter 98, HTSUSA.

Section 222 of the Customs and Trade Act of 1990 (P.L. 101- 382) amended U.S. Note 2, subchapter II, Chapter 98, HTSUS, ("Note 2(b)") to provide for duty-free treatment of articles, other than certain specified products, which are assembled or processed in a Caribbean Basin Initiative beneficiary country (BC) wholly of fabricated components or ingredients (except water) of U.S. origin.

Note 2(b) explicitly requires that all components or ingredients be of U.S. origin. Since the magnetic tape roll is of Japanese origin, the pre-recorded videocassettes are ineligible for duty-free treatment under Note 2(b).

2. Eligibility for duty-free treatment under CBI.

Under the CBI, eligible articles the growth, product or manufacture of designated beneficiary countries (BC's), may enter the U.S. free of duty if such articles are imported directly to the U.S. from the BC, and if the sum of (1) the cost or value of the materials produced in a BC or BC's, plus (2) the direct cost of processing operations performed in a BC or BC's, is not less than 35% of the appraised value of the article at the time it is entered into the U.S. See 19 U.S.C. 2703(a). The cost or value of materials produced in the U.S. may be applied toward the 35% value-content minimum in an amount not to exceed 15% of the imported article's appraised value. See section 10.195(c), Customs regulations (19 CFR 10.195(c)).

As stated in General Note 3(c)(v)(A), HTSUSA, the Netherlands Antilles is a BC for CBI purposes. In addition, it appears that the duplicated videocassettes are classified in subheading 8524.23.10, HTSUSA, which is a CBI-eligible provision.

Where an article is produced from materials imported into a BC from non-BC's, the article is considered a "product of" the BC only if those materials are substantially transformed into a new and different article of commerce. See 19 CFR 10.195(a). In addition, if an article is comprised of materials that are imported into the BC, the cost or value of those materials may be included in calculating the 35% value-content requirement only if they undergo a "double substantial transformation" in the BC. See Section 10.196(a), Customs Regulations (19 CFR 10.196(a)). Azteca Milling Co. v. United States, 703 F.Supp. 949 (CIT 1988), aff'd 890 F.2d 1150 (Fed. Cir. 1989).

The test for determining whether a substantial transformation occurs is whether an article emerges from a process with a new name, character, or use different from that possessed by the article prior to processing. Texas Instruments, Inc. v. United States, 69 CCPA 152, 156, 681 F.2d 778, 782 (1982).

In Headquarters Ruling Letter (HRL) 555778, dated February 15, 1991, Customs held that video duplicating operations constituted a substantial transformation. However, we further found that no second substantial transformation resulted from the production of the videocassettes, and, therefore, the cost or value of the materials imported into the B.C. were not includable in the 35% value-content requirement. Consistent with HRL 555778, we conclude that the videocassettes produced in this case are considered "products of" the Netherlands Antilles for CBI purposes, but no second substantial transformation is performed on the materials imported into the Netherlands Antilles. Therefore, in order to receive duty-free treatment under the CBI for the videocassettes at issue, the 35% value-content requirement must be met by the direct costs of processing performed in the Netherlands Antilles, plus the cost or value of U.S.-origin materials, which cannot exceed 15% of the appraised value of the videocassettes.

Direct costs of processing are those costs which are 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 personal." See 19 CFR 10.197(a)(1). Although you have provided some figures for calculating the value-content requirement, you have not provided adequate figures which would allow us to make a binding determination of whether the 35% value-content would be met. As provided in section 10.195(a)(1) of the Customs Regulations (19 CFR 10.195(a)(1)), the 35% value-content test is based on the appraised value of the article at the time it is entered into the U.S., which generally is the actual price paid or payable for the merchandise when sold for exportation to the U.S.

We can comment on some of the cost calculations that you did provide. Whether particular labor costs constitute a direct cost of the processing operation is generally determined by the function the employee performs. See HRL 555043 dated November 21, 1988. For example, the costs of workers directly engaged in the production of the eligible article, including wages, salaries, bonuses, group insurance, and payroll taxes, are direct processing costs. See C.S.D. 80-246 dated April 23, 1980.n-4-

However, costs associated with employees who perform only administrative functions, such as a general manager, a personnel manager, or accounting and payroll employees are not considered a direct processing cost. See HRL 541249 dated February 24, 1977. Accordingly, if the cost percentages you have provided concerning wages, social security, and vacations and bonuses, are for those workers considered directly engaged in the production of the videocassettes, those costs are correctly included as direct costs of processing. See HRL 555316 dated April 26, 1989.

Costs of utilities, such as electricity and water, are direct costs of processing operations to the extent that they are actually used in the production process. See C.S.D. 84-26. For example, electricity used to operate equipment in the production of the videocassettes is a direct cost of processing. Similarly, a pro-rata share of the cost of electricity used for lighting the work area where the videocassettes are manufactured would also be a direct cost of processing, [See C.S.D. 80-208 dated March 24, 1980], but the cost of electricity used for lighting or air conditioning administrative offices would not be includable. Therefore, the electricity and water costs that you have provided are eligible for use in the direct costs of processing calculations as long as they are used directly in the manufacturing process.

The cost of maintenance, repair, or modification of equipment used in the production of the videocassettes is a direct cost of processing and also can be included in the 35% cost calculations. See C.S.D. 80-246. In addition, depreciation on machinery and equipment that is used in the production of the videocassettes is also a direct cost of processing. Accordingly, depreciation expenses may be included toward the 35% requirement.

Rent on that portion of the building space directly used in the processing operations is considered a direct processing cost, but the percentage of building space used for personnel offices, accounting departments and other administrative functions would not be so considered. See, HRL 541249 dated February 24, 1977. Therefore, the 1.4% of building rent that you have provided may be included in the 35% calculations if it is only that portion which is directly related to the manufacturing portions of the building.

Only those interest costs which are attributable to mortgage interest on real property are considered a direct cost of processing. Therefore, the percentage of value added which is attributed to interest payments, can be included only if that interest is for a mortgage on real property. n

In your submission you provide that a small percentage of value is attributable to "contingencies". Without further elaboration of what these costs entail we would not allow this portion of costs to be included in the 35% value calculations.

HOLDING:

The magnetic roll tape used in the production of the pre- recorded videocassettes are not of U.S.-origin, and, therefore, precludes duty-free treatment under Note 2(b) for the pre- recorded vidoecassettes.

However, the pre-recorded videocassettes are a "product of" the Netherlands Antilles for purposes of CBI. Therefore, if they are imported directly into the U.S., and the 35% value-content requirement is satisfied by the direct costs of processing (as established in accordance with the applicable regulations), plus the cost or value of U.S.-origin materials (up to a maximum of 15% of the appraised value), the videocassettes will be entitled to duty-free treatment under the CBI.

Sincerely,

John Durant, Director

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