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HQ 545175




January 4, 1975

VAL CO:R:C:V 545175 IOR

CATEGORY: VALUATION

District Director
San Francisco, CA

RE: Contract cancellation charges; price actually paid or payable

Dear Sir:

This is in response to your internal advice request dated October 20, 1992 regarding the inclusion in transaction value of contract cancellation charges paid by xxxxxxxx xxxxxxxxx x xxxxxxxxx xxx (hereinafter referred to as the "importer") to its supplier. We are in receipt of the importer's submission dated October 9, 1992, and a supplemental submission dated September 21, 1994. This response follows a December 14, 1994 meeting between counsel for the importer and members of my staff in the Value Branch. We regret the delay in responding.

FACTS:

The subject imported merchandise consists of 458,500 telephone answering systems imported pursuant to a November 4, 1991 contract. The importer had entered into a contract to purchase an indeterminate number of telephone answering systems from its unrelated overseas supplier, Standard Telecommunications Ltd. (hereinafter referred to as the "seller") from October 1, 1991 through September 30, 1992. The contract was for several different models of answering systems, including model 1516. According to the importer's submission, the seller's pricing for model 1516 was based on the importer's initial estimate that it would purchase 700,000 units of all models, and took into account overhead, materials to be purchased and technical staff dedicated to the subject merchandise.

In December 1991, the importer revised its projected requirement of all models downward from the 700,000 units, and specifically cancelled the production of model 1516. The last shipment of model 1516 was made on February 16, 1992 when only 12,200 units of model 1516 had been imported.

The contract provides that the importer cannot be held responsible for the seller's losses, except in the case of a termination of a purchase order. However, in the interest of maintaining good will with the seller, the importer reimbursed the seller for work in progress and materials for model 1516 and costs incurred for overhead and labor which was reserved but not used as a result of the reprofiling and cancellation of model 1516. The seller invoiced the importer for these amounts in February and March 1992. The invoices from the seller identified the charges as "cancellation charges" for model 1516 and as "overhead and labour cost" due to "reprofile and 1516 cancellation." The importer's internal documents refer to the invoices as being for cancellation of model 1516 and overhead and labor losses due to reprofiling.

According to the importer, in the importer's accounts, the cancellation payments were accounted for separately from the payments for the imported answering machines. The importer's September 21, 1994 submission describes how the cancellation charges were booked to a separate cost clearing account for non-operating variables as opposed to the inventory account and that the cancellation fees are viewed as period expenses by AT&T.

The importer takes the position that these amounts paid are cancellation charges and as such are not part of the price actually paid or payable for the imported merchandise.

ISSUE:

Whether the importer's payment to the seller, for costs incurred for work in progress, materials, and overhead and labor for merchandise which was contemplated by contract but never ordered by the importer, is part of the price actually paid or payable for other merchandise imported pursuant to the same contract.

LAW AND ANALYSIS:

The subject merchandise is being appraised under transaction value, which is defined by ?402(b)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA, 19 U.S.C. 1401a(b)) as "the price actually paid or payable for the merchandise when sold for exportation to the United States..." plus certain additions specified in ?402(b)(1) (A) through (E).

Customs has held that a payment from the buyer to the seller for cancellation of a production order or ordering less merchandise than anticipated, does not constitute part of the price actually paid or payable for the merchandise already imported when it has been established that the payment is clearly a charge for termination and merchandise is not imported to the U.S. as a result of the terminated contract. See Headquarters Ruling Letter (HRL) 543770 dated October 23, 1985; HRL 544121 dated June 24, 1988.

The issue of "shortfall fees" was recently addressed by the Court of International Trade in Chrysler Corporation v. United States, No. 93-186, slip op. (Ct. Int'l. Trade Sept 22, 1993). The Court stated that "[a]n expense arising from the failure to purchase certain merchandise is not a component of the price paid for the acquisition of other products." Slip-op. at 11 (emphasis supplied). In Chrysler, the shortfall fees were provided for in the purchase contracts between the importer and the manufacturer. The Court also considered how the shortfall fees had been treated in the importer's accounting records. The Court held that as the subject fees were not a component of the price of the imported merchandise, but an independent and unrelated cost assessed because the importer failed to purchase a specified quantity of merchandise, and as the fees were treated separately from the cost for the imported merchandise, the fees were not part of the price actually paid or payable for the imported merchandise. Id. at 14.

In the instant case, as in Chrysler, in the importer's internal accounting the cancellation payments were accounted for separately from the invoice price of the imported merchandise and were expensed as opposed to being added to the cost of the inventory. In this case the cancellation fees are not provided for in the purchase agreement between the parties, and the importer was not contractually required to purchase a specified quantity of merchandise. However, the seller's invoices, the importer's documentation and accounting records establish that the fees are for expenses incurred with respect to merchandise that was not imported. In this case there is sufficient evidence that the cancellation payments made by the importer are not part of the price actually paid or payable for the imported merchandise.

HOLDING:

Under the facts presented and evidence submitted in this case, the importer's payments to the seller, for costs incurred for work in progress, materials, and overhead and labor for merchandise which was contemplated by contract but never ordered by the importer, are not part of the price actually paid or payable for the imported merchandise.

This decision should be mailed by your office to the internal advice requester no later than 60 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, Freedom of Information Act and other public access channels.

Sincerely,

John Durant, Director
Commercial Rulings Division

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