HQ 0544662 - Internal Advice Request *****; Pre-Penalty Case 89-1001- - United States International Trade Commision Rulings

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HQ 544662

March 18, 1994

VAL CO:R:C:V 544662 CRS

CATEGORY: VALUATION

Area Director of Customs
New York Seaport
U.S. Customs Service
6 World Trade Center
New York, NY 10048

RE: Internal Advice Request *****; Pre-Penalty Case 89-1001-

Dear Madam:

This is in reply to the subject internal advice request, filed on behalf of *** (the "buyer), by counsel addition, a submission dated June 14, 1991, was filed in response to the pre-penalty case referred to above. The file contains voluminous correspondence on this matter including submissions dated, respectively, March 6, 1986, March 10, 1989, and September 12, 1989. Meetings to discuss this matter were held with counsel on July 30, 1992, and January 25, 1994. The latter meeting was attended by a representative from the Regulatory Audit Division, New York, and by a Headquarters representative of the Office of Regulatory Audit. Our comments in regard to the appraisement issues raised in the internal advice request follow. We regret the delay in responding.

FACTS:

The buyer imports children's wearing apparel from its The buyer supplies the seller with fabric, trim and accessories on a consignment basis, which materials the seller uses to manufacture wearing apparel. The invoices that accompany the seller's shipments state a dollar value for each style of garment; however, this amount is not actually paid by the importer. Instead the buyer makes regular payments to the seller in varying amounts in addition to furnishing the seller with the materials specified above.

In 1988 the Regulatory Audit Division, New York (the "auditors"), audited entries filed by the buyer between May 1, 1980, and April 30, 1985. The auditors concluded that the buyer undervalued entries filed during the period in question by (Audit Report 2-88-CEF-03, dated March 2, 1988, at 13). Specifically, the audit report identified the following areas in which the buyer's costs were undervalued: "material assists," undervalued by $550,667.00; "labor, overhead and profit," $************; and "second quality" merchandise, undervalued by

In response, the buyer filed a prior disclosure and tendered a total of $************, in checks of equal amount dated July 2, 1985, and September 3, 1985. The auditors subsequently revised their calculations and determined that the actual undervaluation The amount of material undervaluation remained unchanged; however, the undervaluation of labor, overhead and profit was revised downward to $************ and the undervaluation of assists was reduced to $************. The undervaluation of "second quality" merchandise was eliminated from the loss of duty calculation. In a letter dated May 23, 1991, counsel tendered a check for an additional $**********, on behalf of the buyer. This payment perfected the prior disclosure. Pursuant to a pre- penalty notice dated June 5, 1991 (which superseded the original pre-penalty notice of January 11, 1991), the amount of the proposed monetary penalty relating to this matter was set at

In its submissions of February 22, and June 14, 1991, counsel takes issue with the audit findings. First, it maintains that in calculating the value of material assists provided by the buyer to the seller, the audit overstated the buyer's material costs by $************. Second, in regard to labor, overhead and profit, counsel contends that certain packing costs, penalty payments, supervisory charges and tax credits should not be included in the appraised value of the merchandise. Finally, counsel asserts that the audit report overstates the value of certain other assists. In light of the above, counsel maintains that the buyer's entries during the period in question reflect a loss of revenue of no more than $**********, rather than the loss of $************ determined by the audit. Counsel therefore contends that the buyer is entitled to a refund of at least

Furthermore, while the issue of second quality merchandise was dropped from the pre-penalty case, counsel urges in regard to future shipments that Customs "continue its longstanding practice of appraising the buyer's 'seconds' at 50 percent of the value of its first quality garments."

ISSUES:

The appraisement issues presented by the instant advice internal request are: (1) whether transaction value is the appropriate basis of appraisement; (2) whether the amount of the undervaluations determined pursuant to the audit report are properly included in the transaction value of entries filed by the buyer during the period in question; and (3) whether second quality merchandise should be appraised at fifty percent of the value of first quality garments?

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised in accordance with section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (the TAA; 19 U.S.C. 1401a). The preferred method of appraisement under the TAA is transaction value, defined as "the price actually paid or payable for the merchandise when sold for exportation to the United States," plus certain additions, including packing and the value, apportioned as appropriate, of any assist. 19 U.S.C. 1401a(b)(1).

However, imported merchandise is appraised under transaction value only if the buyer and seller are not related, or if they are related, the transaction value is deemed acceptable. Section 402(b)(2)(B) of the TAA provides that a transaction value between a related buyer and seller is acceptable if the circumstances of sale indicate that the relationship did not influence the price actually paid or payable. Alternatively, a transaction value between related is acceptable if it closely approximates, inter alia, the deductive or computed value (test values) for identical or similar merchandise. 19 U.S.C. 1401a(b)(2)(B).
the seller is the buyer's wholly-owned subsidiary. Accordingly, the seller and the buyer are related parties within the meaning of section 402(g) of the TAA which provides, inter alia, that an organization, and any person directly or indirectly owning, controlling, or holding with power to vote, 5 percent or more of the outstanding voting stock or shares of that organization, are related. 19 U.S.C. 1401a(g)(1)(F).

In the instant case the "circumstances of sale" between the buyer and the seller do not validate the use of the transaction value. For example, we understand that payments by the buyer to the seller bear no direct relationship to the invoice value of the imported merchandise. Moreover, the manner in which the buyer invoices "second quality" merchandise suggests that the relationship influences the price actually paid or payable. However, the Area Director, Newark, New Jersey, has advised that the transfer prices, i.e., the invoice values of the entries in question, closely approximates the computed value of identical merchandise. The situation is similar to that in Headquarters Ruling Letter (HRL) 542580 (also cited as TAA No. 41) dated November 4, 1981. There the transfer price represented the seller's full cost of materials, direct labor, overhead, and general expenses and profit. Accordingly, we held that the transfer price would closely approximate the computed value of identical merchandise, thereby validating the use of transaction value. It was first necessary actually to appraise an initial importation on the basis of computed value in order to establish the test value. See also, HRL 544375 dated July 16, 1990.

Similarly, the transfer prices of the imported garments in the instant case were compared to previously accepted computed values. As a result of this comparison the transfer prices were determined closely to approximate the computed value of identical merchandise, provided certain additions were made to the invoice prices. Accordingly, transaction value is an acceptable basis on which to appraise the entries in question.

As stated above, transaction value is defined as the price actually paid or payable for the merchandise when sold for exportation to the United States. For the purposes of section 402, the term "price actually paid or payable" is defined as follows:

(A) The term "price actually paid or payable" means the total payment (whether direct or indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance and related services incident to the international shipment of the merchandise from the country of exportation to the place of importation in the United States) made, or to be made, for imported merchandise by the buyer to, or for the benefit of the seller.

19 U.S.C. 1401a(b)(4)(A).

Material Costs

The buyer provides the seller, the seller, with materials used in the production of finished garments including fabric, trim and accessories. The audit reports concludes that the buyer's claim in regard to material losses should not be allowed because the adjustments to the books were made after the date of the audit and are not supported by documentary evidence. However, counsel contends that the audit report overstates the buyer's material costs by not including these adjustments and submits that this position is supported by the seller's accounts. Specifically, counsel asserts that material losses should not be included in the value of assists furnished by the buyer. The material losses are allegedly attributable to: (1) year-end adjustments to inventory, lost garments charged to contractors, the cost of yarn burned in 1982, and thread not included in 1984 inventory; (2) adjustments for materials returned to the buyer; (3) samples; (4) credit memos on the buyer's books; (5) differences reflected on a discrepancy report totaling $****** (Exhibit 22 of counsel's submission of June 14, 1991); and (6) adjustments in regard to the buyer's invoice no. 83/4525 (Exhibit C). Submission of June 14, 1991, at 8-10.

The term "assist" refers to certain items supplied directly or indirectly, and free of charge or at a reduced cost, by the buyer of imported merchandise for use in connection with the sale for export to U.S. of the merchandise. Under transaction value, the value of assists, apportioned as appropriate, are an addition to the price actually paid or payable. Pursuant to section 402(h)(i) of the TAA the term "assist" includes, inter alia, "materials, components, parts, and similar items incorporated in the imported merchandise." 19 U.S.C. 1401a(h)(i). The materials furnished by the buyer to the seller include fabric, trim and accessories incorporated in the imported merchandise. Accordingly, the materials furnished by the buyer constitute assists.

The audit report notes that one adjustment to the cost of material assists was made for a shipment that had been highjacked. This adjustment was documented by an insurance claim. Nevertheless, in regard to the balance of the material assist costs, the audit report states that the claimed adjustments were not reflected in the buyer's accounts as of the date of the audit and, consequently, were disallowed. This issue was extensively discussed at the January 25, 1991, meeting. In support of the buyer's position, counsel submitted documentation consisting of excerpts from the seller's December 31st and January 1st trial balances for the period in question. Counsel has also cited HRL 543093 for the proposition that materials that are destroyed, scrapped, lost and are not physically incorporated into imported merchandise are not assists under the TAA.

In light of the information presented by counsel we are persuaded that the claimed adjustments were properly recorded on the books of the seller and that the buyer's material assists were therefore not overstated. Consequently, pursuant to HRL 543093, the value of the materials destroyed and not otherwise incorporated into merchandise imported during the period in question, viz., $550,677.00, should not be included in the appraised value of the imported merchandise.

Labor, Overhead and Profit

Counsel contends that certain other costs identified generally by the audit report under the rubric of "labor, overhead and profit" should not be included in the appraised value of the imported merchandise. These include the cost of "Redipak" packing, and van stuffing and palletizing, as well as certain fines and penalties, supervisory charges and tax credits.

The "Redipak" process is undertaken after finished garments made by the seller come off the assembly line and have been packed in cartons of twenty or more dozen per carton. From the assembly line the cartons containing the garments are taken to an apparently adjoining or nearby location within the plant, and unpacked. There the garments are placed on hangers, wrapped with tissue paper, placed in polybags and packed in boxes holding between six and twelve garments. The costs of the "Redipak" process are borne by the buyer and the service is performed at its request.

Counsel maintains that the finished garments are packed in seaworthy condition, packed ready for shipment to the U.S. before the additional process of preparing them for retail display is undertaken, i.e., before they are submitted to the "Redipak" process. In support of this position counsel cites HRL 542957 dated November 26, 1982, HRL 543026 dated March 17, 1983, and HRL 543985 dated February 1, 1988. These rulings hold generally that where merchandise is packed in ocean containers, on hangers, on racks, in condition ready for shipment to the U.S., payments to third parties for a vacuum packing operation similar to "Redipak" would not be included in the appraised value of the imported merchandise. Consequently, counsel asserts that the cost of the "Redipak" process is not included in the transaction value of the imported merchandise.

Packing costs are an addition to the price actually paid or payable (19 U.S.C. 1401a(b)(1)(A)) and are defined by section 152.102, Customs Regulations which provides:

(e) Packing costs. "Packing costs" means the total cost of all containers (exclusive of instruments of international traffic) and coverings of whatever nature and of packing, whether for labor or materials, used in placing merchandise in condition, packed ready for shipment to the United States.

19 C.F.R. 152.102(e).

In HRL 542834 dated July 20, 1982 (TAA No. 49) a seller of imported merchandise placed goods on racks or hangars at the factory. In a separate transaction, the importer/buyer of the merchandise contracted with an unrelated third party to collect the goods from the seller, deliver them to a packaging plant where they were vacuum packed and placed in export containers or on pallets, and then deliver them to a carrier for international shipment. Citing to a prior ruling (HRL 400077), we noted that the importer/buyer had the burden of establishing that the merchandise is packed ready for shipment, i.e., in a seaworthy condition, prior to being placed in a container. Based on the facts in HRL 542834 we held that the merchandise was not packed ready for shipment and, therefore, that the cost of vacuum packing, etc., were part of packing costs and should be included in the appraised value of the merchandise. See also HRL 544993 dated October 9, 1992.

In the instant case, the "Redipak" process is performed by the seller, the buyer's wholly-owned subsidiary, rather than by an unrelated third party. Where we have held that the cost of vacuum packing was not part of the price actually paid or payable for imported merchandise, payment therefor has been made to an unrelated third party. Secondly, no documentation or other evidence has been submitted to establish that the first packing operation is sufficient to place the garments in a seaworthy condition such that they would be considered ready for shipment to the U.S. Indeed, we are advised by the concerned National Import Specialist and the Office of Trade Operations that what is described as the "bulk packing" operation is in all likelihood simply a method of moving finished garments from the production line to the place where the garments packed. Accordingly, counsel has not met the burden of establishing that the garments were packed ready for shipment prior to being submitted to the "Redipak" process. Thus the "Redipak" process, rather than being additional packing, is in fact the sole method of packing the garments for shipment to the U.S. Packing costs are an addition to the price actually paid or payable. 19 U.S.C. 1401a(b)(1)(A). Accordingly, costs related to the "Redipak" process were properly included in the transaction value of the entries in question.

Counsel also maintains that the cost of "van stuffing and palletizing" performed by the seller should not be included in transaction value. These amounts include the cost of placing Redipak cartons on pallets, strapping the cartons to the pallets, and placing the pallets into vans or containers. In support of its position counsel cites HRL 543518 dated September 3, 1985, in which we held that certain loading charges were incidental to international shipment and therefore not dutiable. We note, however, that our decision in that case was influenced by the fact that in some instances the loading charges were included as an indivisible amount in the freight charges. This is not the case here. Moreover, in HRL 542834 we stated that the placement of merchandise on pallets should be included in the addition for packing since the cost was incident to placing the merchandise in condition, packed, ready for shipment to the U.S. Accordingly, it our position that the van stuffing and palletizing costs are incident to placing the garments in condition, packed ready for shipment and are part of the price actually paid or payable.

The final elements of the "labor, overhead and profit" category identified in the audit report consist of amounts for fines and penalties, supervisory charges, and "BOI tax credits." Based on the information presented by counsel it is our position that these amounts should not be included in the appraised value of the merchandise.

Assists

The auditors initially determined that the buyer undervalued "assists," other than material assists totaling $************. Subsequently it was determined that $************ relating to supervisory salaries was not dutiable, thereby reducing the undervaluation of "assists" to $************. Letter from Fines, Penalties and Forfeitures dated April 22, 1991. Counsel has stated that "[i]ncluded in this total are certain costs relating to insurance, equipment, parts, and salaries, all of which the buyer agrees are dutiable." Submission of June 14, 1991, at 21- 22. Since counsel has not raised any further questions concerning the inclusion of these costs we have no further comments in regard to this issue.

Defective Merchandise

In its submission of February 22, 1991, counsel raised a question in regard to the valuation of second quality garments which it states that the buyer resells in the U.S. at fifty percent of the regular sales price for such garments. The buyer entered these second quality garments at reduced values, generally fifty percent of first quality merchandise. Counsel stated that this practice was disclosed to, and accepted by, Customs at the time of entry, and therefore maintained that Customs should abandon its claim for increased duties in this regard.

This claim was in fact dropped from the pre-penalty proceeding. Nevertheless, in its submission of June 14, 1991, counsel states that "[w]hile the Customs Service has agreed that the penalty period loss of revenue should not be increased to reflect first quality prices for second quality goods...it is our understanding that [Customs] wished to revisit this issue in the context of current shipments." Submission of June 14, 1991, at 33-34. In view of this, counsel restated its contention that the buyer's practice of entering "second quality" merchandise at fifty percent of the value of first quality merchandise was in conformity with the law and regulations.

The buyer's merchandise is appraised under transaction value, i.e., on the basis of the price actually paid or payable by the buyer to the seller, plus the enumerated additions, to the extent applicable, but exclusive of the cost of international transport. Section 402 of the TAA does not distinguish between different classes of merchandise, e.g., between first and second quality goods. Accordingly, there is no authority under the TAA for the buyer to enter is "second quality" merchandise at fifty percent of the value of first quality merchandise. However, when imported merchandise is defective, an allowance may be made.

In this regard, section 158.12, Customs Regulations (19 C.F.R. 158.12), provides in pertinent part:

(a) Allowance in value. Merchandise which is subject to ad valorem or compound duties and found by the district director to be partially damaged at the time of importation shall be appraised in its condition as imported, with an allowance made in the value to the extent of the damage....

In order for an allowance to be made the buyer/importer must provide Customs with clear and convincing evidence to support a claim that merchandise purchased and appraised as one quality was in fact of a lesser quality. C.S.D. 84-12, 18 Cus. B. & Dec. 849, 852 (1984). If there is nothing to substantiate an assertion that merchandise is defective, then no allowance may be made. HRL 544879 dated April 3, 1989.

Accordingly, in regard to future entries, unless the buyer presents acceptable evidence that merchandise is in fact defective, no allowance in value may be made.

HOLDING:

The transfer price between the buyer and the seller closely approximates the computed value of identical merchandise and transaction value is therefore the appropriate basis of appraisement for the buyer's entries during the period in question.

The adjustments to the value of the material assists at issue were properly recorded on the seller's books and do not represent the undervaluation of the entries in question. Similarly, amounts for fines and penalties, supervisory charges, and BOI tax credit, identified in the audit report under the general heading of "labor, overhead and profit," should not be included in the undervaluation of the entries in question.

Packing expenses as represented by charges for the "Redipak" process and for "van stuffing and palletizing," which also were identified in the audit report under the general heading of "labor, overhead and profit," were undervalued in the amounts specified in the audit report. Non-material "assists," that pertain to insurance, equipment, parts and salaries, but not to supervisory salaries, were also undervalued in the amount specified by the audit report, as modified by the letter from Fines, Penalties and Forfeitures dated April 22, 1991.

Allowances for defective merchandise should be made by the concerned import specialist pursuant to 19 C.F.R. 158.12, only on the basis of sufficient evidence.

This decision should be mailed by your office to the internal advice requester no later than sixty days from the date of this letter. On that date the Office of Regulations and Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Lexis~, the Freedom of Information Act and other public access channels.

Finally, since a pending action under 19 U.S.C. 1592 is involved we would appreciate expedited treatment of this matter.

Sincerely,

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