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HQ 556604

February 23, 1993

CLA-2 CO:R:C:S 556604 WAW

CATEGORY: CLASSIFICATION

District Director
U.S. Customs Service
P.O. Box 9516
El Paso, TX 79985

RE: Reconsideration of HRL 556045 concerning the eligibility of telecommunications switching equipment for duty-free treatment under the GSP; substantial transformation

Dear Sir:

This is in response to your request for Internal Advice dated March 6, 1992, concerning the eligibility of telecommunications switching equipment for duty-free treatment under the Generalized System of Preferences (GSP) (19 U.S.C. 2461-2465). In Headquarters Ruling Letter (HRL) 556045 dated July 24, 1991, we issued a ruling which held that the components imported into Mexico and used in the production of telephone bantam jacks (TBJ's), which are used in the final assembly of a DS1 module and wired assembly were subjected to a double substantial transformation in Mexico. Therefore, we held that the cost or value of the components imported into Mexico could be included toward the 35% value-content requirement of the GSP. You have asked that we reconsider our position in HRL 556045.

FACTS:

The importer, ADC Telecommunications, Inc.(ADC), supplies parts of both U.S. and foreign origin to an unrelated Mexican company, Elamex S.A. (Elamex). Elamex takes the parts at no cost and assembles them into the DS1 and wired assembly, and charges ADC an assembly fee. TBJ's are utilized in the final assembly of the DS1 module and the wired assembly. The TBJ can be assembled in three types, samples of which have been submitted. All three types of TBJ's consist of springs (with contacts welded on), spacers, screws, screw insulators, and in addition, two of the three types include push rods. These parts are attached to a die- cast zinc frame, which comprises the principal structural element of the TBJ.
In order to verify the seven steps described below in the production of the TBJ, three import specialists from your office visited ELAMEX's plant in Mexico. ADC's description of each step in the production process was listed in your memorandum followed by comments based upon the information obtained during the import specialists' visit to the assembler's premises. In support of its position, ADC submitted its own response dated July 13, 1992, clarifying your office's description of the steps involved in assembling the TBJ's. The following is a description of the steps in the assembly of the three types of TBJ's:

(1) Reform metal springs for specific application. Certain of the springs are placed in an air press and reformed to specific dimensions. These dimensions vary among the different assemblies, but are precisely defined. The reforming is necessary because the springs lack uniformity due to variations in the hardness and curvature of the spring material.

The representatives from your office reported that the springs are all preformed and shaped in the U.S. before being sent to Mexico and that the term "specific dimensions" used by the importer is exaggerated, since only one metal spring is slightly bent in Mexico. The importer responded by stating that "there is one spring per assembly for two of the three assemblies which needs additional forming." The importer further stated that although the metal spring may be slightly bent, fine tolerances are involved in this case so that even a slight bend is significant in this case.

(2) Peen push rod to spring. The push rod is manually inserted into a hold in the relevant spring. One end of the push rod is then compressed, or "peened," with an air press. The resulting broadening of that end of the push rod securely affixes it in place to the spring.

Your office claimed that the push rod is used on model P-40 and that the operation described above is simple and is done before the assembly of the stacks. The importer claims that the push rod is used in two of the three TBJ assemblies.

(3) Stack parts. The screw insulator is placed over two stacking pins. The springs and spacers are stacked on the insulator in accordance with a predetermined scheme, allowing the precisely- located contacts on the springs to mate, in the short and long stacks.

Your office states that the assembly of the short and long stacks is done simultaneously on a table about 25 meters long with operators on both sides of the table. According to your office, the assembly of the components involves simply dropping the components onto the screw insulators, thus forming long and short stacks. The importer, however, states that the springs and spacers cannot be simply dropped onto the screw insulator; they must be positioned, in sequence, on the insulator and then released.

(4) Stake parts to frame. A short and long stack are attached to the frame, using two self-tapping screws for each stack, on a dual staking machine. This machine holds the TBJ in place while the two screws are driven through the insulators and into the die-cast frame to a predetermined and specific torque. This operation is critical because too much torque will strip the threads out of the soft metal frame, and too little torque will cause the stacks to be loose, rendering the jack non-functional. Because this operation is so critical, a strict program of statistical process control has been established. This means that every hour a quality control inspector takes a sampling of the production run. The inspector tests the torque of the stack screws with a manual torque meter. If the stack screw torque is less than two inch pounds, a skilled maintenance technician is called in to determine what the problem is and to solve it. After the problem is solved, the technician will readjust the torque, using a universal torque analyzer.

Your office claims that the 99.3 percent average efficiency for this assembly operation is indicative of its simplicity, and that none of the critical operations that were described by the importer were observed. Moreover, your office states that only 0.7 percent of the assembly production is ever returned for rework. The importer claims that the high efficiency rate is indicative of a complex, and not simple, process that entails and achieves "Total Quality." "Total Quality" is both an end-result in the product, as well as a continuous process that includes, among other things, employee training, technological improvements, and statistical process control.

Representatives from your office claim that the only evidence of testing was at the calibration and testing station for the TBJ's. However, the importer states that a technician tests the torque of the stack screws once every two hours. The importer claims that the test equipment and machinery is calibrated at least once every six months, and is adjusted whenever necessary.

5) Adjust springs for proper alignment and contact. The springs in the TBJ must be precisely adjusted so that the contacts are properly aligned. Nine separate adjustments need to be made. The tolerances for these adjustments are measured to ten one- thousandths (.010) of an inch. Each set of contacts is tested and adjusted by hand by skilled technicians to establish the exact amount of contact opening, closing, and wipe. The contacts are required to open a minimum of seven one-thousandths (.007) of an inch with the insertion of a mating plug. With the mating plug removed, the contacts must remain closed with a force of up to ten ounces applied. Contacts must have visible (minimum of four one- thousandths (.004) of an inch) wiping action. Wipe refers to the rubbing action between two contacts as they open and close. This rubbing is necessary to keep the contacts clean. Too much wipe, however, will cause excessive contact wear and shorten the life of the assembly.

Your office claims that the description of the adjustments is very romanticized and exaggerated. You claim that, in reality, the process of adjusting these units is simple and quickly done by a minimum of one and a maximum of two operators by using a hand tool with an extension that resembled a plug. To the contrary, the importer states that the production of 12,000 TBJ's per day requires an average of 14 adjustors working. Moreover, the importer claims that the plug does not do the adjusting, but rather, that each of the springs is manually reformed using a duck bill pliers. After the initial adjusting, the calibrated plug is inserted into each TBJ port, one at a time, to precisely move the tip springs and ring springs so that each set of contacts is opened and closed.

(6) Auto splice springs. On two of the three jacks, an auto splice connection is made. In this application, two spring tails are electrically interconnected by wrapping a piece of brass flat wire around the two tails. The final step provides a gas-tight seal between the two springs by using an auto splice machine.

Your office states that the so-called gas-tight seal created by wrapping the brass wire, is not gas-tight since the brass wire wrapping displays small openings, as do the interconnected spring tails in the finished product. The importer has provided documentation to show that, in fact, the auto-splice must provide a gas-tight connection.

(7) Test TBJ. Each TBJ is manually tested by the insertion of a test plug that is similar to the type of plug for which the TBJ is intended to be used. The illumination of lights on a special adjustment fixture indicates a properly assembled and adjusted TBJ. Any TBJ that fails this testing must be readjusted as described in Paragraph 5 above.

You claim that the testing is a simple operation. However, the importer claims that, although this process may look simple, a significant amount of work has gone into perfecting the equipment and the process. Each of the adjusting/testing stations consists of a custom-made test fixture and power supply which has been designed for this application.

ISSUE:

Whether the materials imported into Mexico which undergo various operations in the production of the TBJ's and, ultimately, the DS1 module and wired assembly are subjected to a double substantial transformation, thereby enabling the cost or value of these materials to be counted toward the 35% value-content requirement for purposes of the GSP.

LAW AND ANALYSIS:

Under the GSP, eligible products the growth, product of manufacture of a designated beneficiary developing country (BDC) which are imported directly into the U.S. qualify for duty-free treatment if the sum of (1) the cost or value of the material produced in a BDC, plus (2) the direct costs involved in processing the eligible article in the BDC, is not less than 35% of the appraised value of the article at the time it is entered into the U.S. See section 10.176(a), Customs Regulations (19 CFR 10.176(a)).

As stated in General Note 3(c)(ii)(A), Harmonized Tariff Schedule of the United States Annotated (HTSUSA), Mexico is a designated BDC. In addition, the products at issue are classifiable in subheading 8517.90.05, HTSUSA, which provides for electrical apparatus for line telephone or telegraphy . . . Parts: Of telephonic apparatus: Of telephone switching apparatus: of the switching apparatus of subheading 8517.30.15. Articles classified under this subheading are eligible for duty-free treatment under the GSP provided they meet all of the applicable requirements.

The cost or value of materials which are imported into the BDC to be used in the production of the article, as here, may be included in the 35% value-content computation only if the imported materials undergo a double substantial transformation in the BDC. That is, the non-Mexican components must be substantially transformed in Mexico into a new and different intermediate article of commerce, which is then used in Mexico in the production of the final imported article, the wired assembly and DS1. See section 10.177(a), Customs Regulations (19 CFR 10.177(a)), and 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 has occurred 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. See Texas Instruments Inc. v. United States, 69 CCPA 152, 681 F.2d 778 (1982).

Customs has previously held that cutting or bending materials to defined shapes or patterns suitable for use in making finished articles constitutes a substantial transformation. See Headquarters Ruling Letter (HRL) 055684 dated August 14, 1979 (holding that those components of a water cooler gas absorption refrigeration unit which were formed by cutting to length, cleaning, and bending imported steel tubes into the required component shapes and configurations, or by cutting to length, flattening, and drilling holes into imported tubing, were substantially transformed constituent materials for GSP purposes, while those imported tubes which were simply cut to length and assembled into the final article were not); HRL 071788 dated April 17, 1984 (forming 18 karat gold wire into circles, ovals, and other specially designed links for bracelets results in a substantial transformation); and HRL 555532 dated September 18, 1990 (shearing cold rolled steel to rectangular shape, piercing to form the various openings and roll forming the steel into tubular shape result in a substantial transformation). In each of the above cases, the raw material had numerous uses before undergoing the cutting operations and possessed little or nothing in its character to indicate its ultimate shape or purpose. The number and variety of potential uses was restricted and the essential character was permanently determined only after the cutting processes were performed.

We find that the operations which consist of reforming metal springs to specific dimensions, peen pushing the rod to the spring, stacking the spring and spacers onto the insulator, staking the parts to the frame of the TBJ, adjusting the springs in the TBJ so that the contacts are properly aligned, wrapping a piece of brass flat wire around two of the tails of the springs to create an auto splice connection, and testing the TBJ, substantially transform the imported materials into new and different articles of commerce. In HRL 555264 dated July 3, 1989, we held that cutting rolls of imported aluminum strips into lengths and crowning the cut strip substantially transform the imported strip into a new and different article of commerce. We have also held in HRL 555811 dated March 20, 1992, that aluminum flat coil stock which has been die cut, stamped and shaped into components which are used in the assembly of an Opposed Roll-Formed Blade Damper, LS4 Supply Grille, and the L.M.H. Supply Grille, undergo a double substantial transformation.

We find that the operations performed in the instant case are analogous to the operations performed in HRL 555264, 555811 and the above-mentioned cases. Therefore, it is our determination that the combination of reforming metal springs, peen pushing the rod to the spring, stacking the spring and spacers onto the insulator, staking the parts to the frame of the TBJ, adjusting the springs to specific alignments, auto splicing the ends of the springs, and testing the TBJ constitute a single substantial transformation of the U.S. and foreign-origin components into "products of" Mexico. The TBJ's produced in Mexico clearly have a name, character, and use different than their component materials. Until the TBJ is formed, the springs bent to shape, the push rod inserted into a hole in the relevant spring, the springs and spacers stacked onto the insulator, the parts staked to the frame, and the completed article adjusted and tested, the U.S. and foreign materials clearly cannot function as a TBJ, do not have the shape or form of a TBJ, and are not known and cannot be classified for tariff purposes as a TBJ. The U.S. and foreign materials have, therefore, been substantially transformed into a TBJ. Furthermore, in view of the importer's claim that the TBJ's are put into inventory as discrete items and may be shipped for use as parts in telecommunications switching equipment, they may be considered "articles of commerce" for GSP purposes. See Azteca Milling Co. v. United States, 703 F. Supp. 949 (CIT 1988), aff'd, 890 F.2d 1150 (Fed. Cir. 1989).

We also find that a second substantial transformation occurs as a result of the assembly of the TBJ's with other materials to create the DS1 and wired assembly. A TBJ is a device which permits access to signals transmitted through the DS1 and wired assembly and provides a way to connect the DS1 and wired assembly to other products. A TBJ by itself cannot perform the function of a DS1 or wired assembly, but must be joined with other wire harnesses, a frame and numerous other components to create the final article. Accordingly, as a result of the assembly, a new and different article of commerce with a new name, character, and distinct function is created.

In C.S.D. 89-129, 23 Cust. Bull. 901 (1989), inductor coils assembled from imported materials were held to be substantially transformed constituent materials of the control transformer. In that case, the inductor coils were produced by winding magnet wire or aluminum foil around a bobbin and, after certain electrical tests, the lead assemblies were welded or soldered and the entire inductor was taped.

In the present case, the procedures used to assemble the DS1 and wired assembly are similar to the facts in the above case. The assembly operations used to create the DS1 and wired assembly require more than the simple joining or combining of prefabricated components. In the case of the DS1, it is produced by: inserting the TBJ's into the front cabinet panel, securing with thread- forming metal screws, cross connecting (jumpering resistoring, and bussing) TBJ's with wire by wire-wrapping to the tails of TBJ's, preparing the wire harness by cutting to proper length, stripping, and pre-bending wires, connecting the wire harness to TBJ's by wire wrapping, fixing the terminal blocks to rear panel of cabinet with metal screws, connecting the wire harness to terminal blocks by wire-wrapping, organizing and assembling wire with cable ties, fixing lamp strips to front cabinet panel with metal screws, connecting wire harness to the lamp strip/lamp socket by wire- wrapping, and connecting the other end of the lamp strip harness to the terminal blocks by wire-wrapping. The assembly is completed by securing the designation strips, cable rings, and other hardware to the cabinet panel, and performing electrical breakdown, continuity, and functional tests. These operations are more than simple joining or combining of prefabricated components, but rather, involve the further manufacture of materials prior to assembly. Therefore, for the reasons stated above, it is our opinion that the materials used in the production of the TBJ's which are then used in the production of the DS1 assembly have undergone the requisite double substantial transformation.

The procedures used to assemble the wired assembly are similar to the assembly operations performed on the DS1. The wired assembly is produced by: inserting the TBJ's into the front cabinet panel, cross connecting (jumpering) TBJ's with wire by wire- wrapping to the tails of the TBJ's, preparing the harness by cutting to proper length, stripping, and pre-bending wires, connecting the wire harness to TBJ's by wire-wrapping, fixing 50 pin connectors to loose ends of wire harness by insulation displacement, fixing connectors to chassis by screwing into place, and performing electrical breakdown, and continuity tests. These operations also are more than simple joining or combining of prefabricated components, since further manufacture of materials is required prior to assembly. Therefore, for the reasons stated above, it is our opinion that the materials used in the production of the TB's which are used in the production of the wired assembly have undergone the requisite double substantial transformation.

The second issue presented is what is the value of the U.S. and foreign made parts, as materials "produced in the BDC," pursuant to 19 CFR 10.177(c)(2). It is ADC's position that the value of such parts should include ADC's cost of manufacturing and general expenses, plus ADC's usual profit. In the case of a part purchased by ADC from another U.S. company, ADC states that the value would include ADC's cost of purchase and general expenses, plus ADC's usual profit. The Customs Regulations state what may be included toward the cost or value of materials produced in the BDC where the material is provided to the manufacturer without charge, or at less than fair market value. 19 CFR 10.177(c)(2), specifically states that the cost or value of such materials shall be determined by computing the sum of:

(i) All expenses incurred in the growth, production, manufacture or assembly of the material, including general expenses;
(ii) An amount for profit; and
(iii) Freight, insurance, packing, and all other costs incurred in transporting the materials to the manufacturer's plant.

Thus, according to the regulations, since ADC is providing the U.S. and foreign-origin materials to its assembler in Mexico without charge, the value of the materials produced in the BDC would include ADC's cost of manufacturing and general expenses, plus an amount for ADC's usual profit. However, in circumstances in which ADC purchases parts from other companies, the value of materials produced in the BDC would include only the purchase price plus, if not included in that price, costs incurred in transporting the materials to the manufacturer's plant. There is no authority for also including an amount for ADC's general expenses and profit under the latter circumstances.

The third question posed by the importer is whether section 402(h)(1)(A)(iii) of the Tariff Act of 1930, as amended, which defines dutiable assist to include "merchandise consumed in the production of the imported merchandise," is applicable to the value of the U.S.-made parts under 19 CFR 10.177(c)(2). You state that, in your opinion, materials which do not become a part of the finished product, but which are consumed in the manufacturing process of the imported merchandise qualify as direct costs of processing within the meaning of 19 CFR 10.177. We agree that the cost of materials consumed in the manufacturing process may not be included in the value of materials produced in the BDC under 19 CFR 10.177. According to this provision, "the words 'produced in the beneficiary developing country' refer to the constituent materials of which the eligible article is composed. . ." Merchandise which is "consumed" cannot be considered to be a constituent material of which the article is "composed." We have previously held that if an assist was of such a nature that it would be considered a "direct cost of processing operations," for example, a die press machine or a mold, then it would be includable in calculating the 35% requirement. See HRL 541249 dated February 24, 1977. If on the other hand, the assist were of such a nature that it was not this type of cost, for example, accounting services supplied to the foreign manufacturer, then it would not be includable in the calculation of the "direct cost of processing operations." See HRL 541249. We have insufficient information concerning what is being consumed in the production of the merchandise, and therefore, it is not possible for us to issue an opinion concerning whether the cost or value of this material may be counted toward the direct cost of processing operations.

We disagree with counsel's statement that Section 402 deals with dutiable imports, while the GSP statute is concerned with duty-free imports. Section 402 of the Tariff Act of 1930 relates to the appraisement of imported merchandise, whether dutiable or non-dutiable. Classification of the imported merchandise is determined after appraisement to determine either the rate of duty for the merchandise or whether the merchandise is eligible for duty-free treatment under the GSP.

Therefore, upon reconsideration of HRL 556045, we affirm our conclusion that the materials which comprise the TBJ have undergone the requisite double substantial transformation, thereby permitting the cost or value of these materials to be counted toward the 35% value-content requirement for purposes of the GSP.

You state that HRL 556045 contradicts C.S.D. 85-25, in which we held that an assembly process will not constitute a substantial transformation unless the operation is "complex and meaningful." Of the total production of TBJ's in Mexico, approximately 60 percent are used in the production of telecommunications switching devices in Mexico, while the remaining 40 percent are shipped to the U.S. and receive an allowance in duty under subheading 9802.00.80, HTSUSA. It is your impression that an operation cannot be considered "complex and meaningful" pursuant to C.S.D. 85-25 and still be considered an acceptable assembly operation under subheading 9802.00.80, HTSUSA. You state that if we hold that the assembly of the TBJ's from the component materials results in a substantial transformation, then no allowance of duty under subheading 9802.00.80, HTSUSA, may be made for the same TBJ's.

The GSP statute and subheading 9802.00.80, HTSUSA, are separate and distinct statutes, which have their own legal requirements. We have held that the assembly of in excess of 50 fabricated discrete components onto a printed circuit board by means of wave soldering operations to create a printed circuit board assembly is a "complex and meaningful" operation which results in a substantial transformation for purposes of the GSP. See C.S.D. 85-25. Likewise, the operation of soldering fabricated components onto a printed circuit board would also be considered an acceptable assembly operation pursuant to subheading 9802.00.80, HTSUSA. See 19 CFR 10.16(a). Thus, it is incorrect to state that an operation cannot be considered "complex and meaningful" for purposes of the GSP and still be considered an acceptable assembly operation or an operation incidental to assembly under subheading 9802.00.80, HTSUSA.

HOLDING:

Based on the reasons set forth above, we affirm our initial decision in HRL 556045 that the operations performed on the materials imported into Mexico to create the TBJ's and, subsequently, the DS1 and wired assembly, result in a double substantial transformation of these materials. Therefore, the cost or value of these materials may be counted toward the 35% value- content requirement for purposes of the GSP.

The value of the materials produced in the BDC, since the importer is providing the U.S. and foreign-origin materials to its assembler in Mexico without charge, would include the importer's cost of manufacturing and general expenses, plus an amount for ADC's usual profit. However, in circumstances in which the importer purchases parts from other companies, the value of materials produced in the BDC would include only the purchase price plus, if not included in that price, costs incurred in transporting the materials to the manufacturer's plant. Under the latter circumstances, there is no authority for including an amount for the importer's general expenses and profit.

Sincerely,

John Durant, Director

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See also:

• Tariff No.: 8517.30.15 - Electrical central office telephone switching apparatus
• Tariff No.: 9802.00.80 - U.S. articles assembled abroad, which have not lost their physical identity or have not advanced in value or improved in condition abroad