HQ 557564 - Internal Advice Request No. 71/83; eligibility of personal computers from the Philippines for duty-free treatment under the GSP; double substantial transformation; C.S.D. 85-25 - United States International Trade Commision Rulings

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HQ 557564

January 4, 1994

CLA-2 CO:R:C:S 557564 WAS

CATEGORY: CLASSIFICATION

District Director
U.S. Customs Service
2nd and Chestnut Streets
Philadelphia, PA 19106

RE: Internal Advice Request No. 71/83; eligibility of personal computers from the Philippines for duty-free treatment under the GSP; double substantial transformation; C.S.D. 85-25

Dear Sir:

This is in response to your letter dated September 3, 1993, forwarding a request for internal advice regarding whether a personal computer from the Philippines is eligible for duty-free treatment under the Generalized System of Preferences (GSP) (19 U.S.C. 2461-2466).

FACTS:

The importer states that until September, 1990, Commodore manufactured all of its model A500 personal computers at its factory located in Hong Kong. For reasons involving cost and capacity, the manufacture of the model A500 was transferred to a subcontractor located in the Philippines -- Automated Technology Inc. ("ATI"). Commodore Electronics Ltd. (Hong Kong) ("CELHK") contracted with ATI for the services performed. According to this arrangement, ATI provided the plant, equipment, and labor for the production of the stuffed printed circuit motherboard (PCBA) for the model A500. It then assembled the PCBA into a complete and functional model A500 personal computer.

ATI charged CELHK only for the manufacturing services which it provided. CELHK acquired and purchased from third party vendors and from other Commodore sources all materials necessary for the production of a complete A500 personal computer. CELHK would consign all necessary materials to ATI for their use in the production process. Some materials were shipped from CELHK's warehouse stock located in Hong Kong. Other materials were purchased by CELHK from Philippine vendors and shipped locally to ATI on behalf of CELHK. Finally, some materials were purchased by Commodore Japan Ltd., who would then sell materials to CELHK.

In late 1991, Commodore began construction of its own personal computer manufacturing facility in the Philippines. By the end of June 1992, this factory was fully operational. After June 1992, all of Commodore's Amiga personal computers of Philippine origin were produced in Commodore's factory in the Philippines. Commodore created a new corporate entity in the Philippines to operate the factory. This company is known as "Commodore Philippines B.V."

A description of the production of the A500 personal computer by Commodore Philippines B.V. is as follows:

A bare printed circuit board (PCB) implanted with conductive traces is imported into the Philippines. The PCB is drilled with holes through which many of the semiconductor devices are mounted and secured. A combination of automated insertion equipment and, to a lesser extent, hand insertion is used to mount the semiconductor devices to the board's surface. The bare printed circuit board is mounted to a frame which travels along a pathway. At stages along this path, the automated insertion units place semiconductor devices into or at predesignated locations on the printed circuit board. At the end of the pathway, the frame with the partially-completed PCBA is removed to a location where semiconductor devices or connectors can be inserted manually.

The PCBA within the frame is then placed on another pathway that will carry it through a chemical cleaning process. After the cleaning process, the A500 PCBA is passed over a wave solder machine which creates solder connections of all semiconductor leads protruding through the holes in the board. The PCBA then enters a final chemical cleaning process. After all the semiconductor devices are positioned by the insertion equipment, the board in its frame passes through an infra-red "oven" which causes the solder at the connection points to adhere to the leads of the semiconductor devices. The PCBAs undergo a final test process. Those PCBAs which successfully pass the test and inspection phase are moved from this area. Those PCBAs which fail the testing phase are turned over to technicians to determine where the fault lies and for correction of the problem. This process results in a fully stuffed and functional printed circuit motherboard assembly.

The importer claims that, at this point, the production of the PCBA results in a substantial transformation of the individual components into a new and different article of commerce. The importer states that it has "historically treated PCBAs as a separate article of commerce and has imported many thousands of them for all models of computers." Furthermore, the importer claims that each PCBA type is assigned its own unique part number, is carried in inventories under this part number as separate and distinct from all other merchandise, and each is designated a separate transfer price for the purpose of inter-company transactions.

Next, the PCBA is assembled with other components to produce a completed personal computer system. The importer states that for those models of computer in which the keyboard is an integral part of the system, the PCBA is first mounted in a bottom case subassembly. The PCBA is separated from the casework by an insulation sheet and the top of the PCBA is covered by a shield to prevent emissions. To this subassembly is added a 3.5" floppy disk drive and, in certain models, a hard disk drive, which are both connected to the PCBA. The keyboard subassembly is mounted to the case subassembly to which is also attached appropriate indicator LEDs for on/off and other functions. The top case is then mated to the bottom case after the keyboard ribbon cable and LED labels and various required serial number and FCC certification labels are attached. The unit then undergoes a series of tests to assure that all combined elements are functioning as a whole. The tests evaluate the proper operation of the disk drive(s), keyboard, and the PCBA, which is now controlling all elements of the system. Units which fail this test are turned over to technicians for repair. Those systems successfully passing the testing process are then given a final exterior cleaning and placed in a retail package for shipment to the U.S. To this package is inserted an external power supply, manuals, software disks, and other accessories.

Computer systems with detached keyboards undergo a slightly different assembly process. The fully stuffed PCBA is mounted to a chassis which forms the internal foundation of the computer CPU. On this chassis the various combinations of disk storage devices are also mounted and connected to the PCBA. Depending upon the configuration and features of the CPU being manufactured, an auxiliary memory, video controller, Local Area Network or other such printed circuit board based enhancements will be mounted on the motherboard PCBA. In this type of computer system, the power supply is integral and is now mounted on the chassis and connections are made to the motherboard PCBA and to the disk drive(s) to which power will be supplied.

The importer claims that the cost or value of the bare motherboard imported into the Philippines and the components assembled to the board may be counted toward the 35% value-content minimum for purposes of determining whether the A500 personal computer is eligible for duty-free treatment under the GSP when imported into the U.S. In support of this claim, the importer states that two separate substantial transformations occur during the production of the finished article - A500 personal computer. The importer contends that the first substantial transformation results from the assembly of the mother PCBA in the Philippines. The process of assembling the mother PCBA with the 3.5" floppy disk drive (or hard disk drive in some models), keyboard, power supply, LEDs, and mounting the unit into a top and bottom case to produce the final assembly, constitutes the second claimed substantial transformation.

ISSUE:

Whether the components imported into the Philippines and used in the production of the mother PCBA, which is then incorporated into the model A500 personal computer, have undergone a double substantial transformation, thereby enabling the cost or value of those 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 or 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 101.76(a), Customs Regulations (19 CFR 10.176(a)).

As stated in General Note 3(c)(ii)(A), Harmonized Tariff Schedule of the United States (HTSUS), the Philippines is a designated BDC for purposes of the GSP. In addition, it appears from your description of the merchandise that the product at issue is classified under subheading 8471.91.00, HTSUS, which provides for "digital processing units, whether or not entered with the rest of the system." Articles classified under this provision are eligible for GSP treatment provided, the "product of," 35% value-content and "imported directly" requirements are satisfied.

Where an article is produced from materials imported into the BDC, as in this case, the article is considered to be a "product of" the BDC for purposes of the GSP only if those materials are substantially transformed into a new and different article of commerce. See 19 CFR 10.177(a)(2). The cost or value of materials which are imported into the BDC 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-Philippine components must be substantially transformed in the Philippines into a new and different intermediate article of commerce, which is then used in the Philippines in the production of the final imported article, the personal computer. The intermediate article must be "readily susceptible of trade, and be an item that persons might well wish to buy and acquire for their own purposes of consumption or production." Torrington Co. v. United States, 8 CIT 150, 596 F. Supp. 1083 (1984), aff'd, 764 F.2d 1563 (Fed. Cir. 1985).

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, 782 (1982).

We have previously held in C.S.D. 85-25 dated September 24, 1984 (Headquarters Ruling Letter (HRL) 071827), that the process of incorporating numerous component parts onto a printed circuit board subassembly constituted a processing sufficiently complex to result in the subassembly being considered a substantially transformed constituent material of the final article. The focus of C.S.D. 85-25 was a PCBA which was produced by assembling in excess of 50 discrete fabricated components (e.g., resistors, capacitors, diodes, transistors, integrated circuits, sockets, and connectors) onto a printed circuit board. Customs determined that the assembly of the PCBA involved a large number of components and a significant number of different operations, required a relatively significant period of time as well as skill, attention to detail, and quality control, and resulted in significant economic benefit to the BDC from the standpoint of both value added to the PCBA and the overall employment generated thereby. In addition, Customs found in this case that the PCBA represented a distinct article, different from both the components from which it was made and the matrix printer into which it was incorporated and, therefore, the assembled PCBA constituted an intermediate article within the meaning of 19 CFR 10.177(a). Therefore, it was determined that the cost or value of the PCBA's could be counted toward the GSP 35% value-content requirement. Additionally, C.S.D. 85-25 stated that the factors which determine whether a substantial transformation occurs should be applied on a case-by-case basis. See also C.S.D. 89-118, 23 Cust. Bull. 26 (1989) (HRL 555045 dated July 14, 1989); C.S.D. 88-37, 22 Cust. Bull. 26 (1988) (HRL 554850 dated September 19, 1988); HRL 555206 dated March 10, 1989; and HRL 555727 dated January 31, 1991.

In the present case, we find that the production of the mother PCBA constitutes a substantial transformation of the imported components into "products of" the Philippines. The process of assembling the PCBA in the instant case is closely analogous to the facts in C.S.D. 85-25. Approximately one hundred and fifty components are automatically or manually inserted and soldered into the bare board. It is clear that these individual components imported into the Philippines acquire new attributes, and we find that the PCBA differs in character and use from the component parts of which it is composed. Moreover, the production of the PCBA involves substantial operations (cutting, mounting, soldering, quality control testing, surface mounting technology), which increase the value of the individual components and endow them with new qualities resulting in an article with a new and distinct commercial identity.

The next issue that we must address is whether the final assembly of the mother PCBA with the bottom case subassembly, floppy disk drive and, in some cases, a hard disk drive, keyboard, power supply, top case subassembly, and LED's, constitutes a second substantial transformation, thereby enabling the cost or value of the materials comprising the PCBA to be counted toward the GSP 35% value-content requirement.

In Texas Instruments Inc. v. United States, 681 F.2d 778 (Fed. Cir. 1982), the court implicitly found that the assembly of three integrated circuits, one photodiode, one capacitor, one resistor, and a jumper wire onto a flexible circuit board (PCBA) constituted a second substantial transformation. C.S.D. 85-25 sets forth basic criteria for determining what type of assembly constitutes a substantial transformation. Based on the criteria in C.S.D. 85-25, it would appear that the assembly procedure in Texas Instruments does not achieve the level of complexity contemplated by C.S.D. 85-25. However, as the court pointed out in Texas Instruments, in situations where all of the processing is accomplished in one GSP beneficiary country, the likelihood that the processing constitutes little more than a pass-through operation is greatly diminished. Consequently, if the entire processing operation performed in the single BDC is significant, and the intermediate and final articles are distinct articles of commerce, then the double substantial transformation requirement will be satisfied. Such is the case even though the processing required to convert the intermediate article into the final article is relatively simple and, standing alone, probably would not be considered a substantial transformation. See HRL 071620 dated December 24, 1984 (in view of the overall processing in the BDC, materials were determined to have undergone a double substantial transformation, although the second transformation was a relatively simple assembly process, which, if considered alone, would not have conferred origin).

Despite the incorporation of several components, the final assembly of the model A500 personal computer does not appear to be exceedingly complex, as contemplated by the criteria set forth in C.S.D. 85-25. However, we do not believe that the overall processing necessary to create the completed article is the type of simple or minimal "pass-through" operation that should be disqualified from receiving GSP benefits. See C.S.D. 85-25; HRl 076160; see also HRL 555921 dated June 17, 1991 (the complex assembly of a completed printed circuit board assembly (PCBA) with a plastic housing, cathode ray tube (CRT), and other parts to create a computer terminal results in a second substantial transformation); C.S.D. 89-118 (the assembly of the PCB's with the base, cover, and power supply, creating the final product - cable television equipment - results in a second substantial transformation).

HOLDING:

Based on the information submitted, we are of the opinion that the production of the mother PCBA and the final assembly with other components to create the model A500 personal computer constitutes a double substantial transformation. Therefore, the cost or value of the materials imported into the Philippines and used to produce the mother PCBA may be counted toward the GSP 35% value-content requirement.

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, Lexis, Freedom of Information Act and other public access channels.

Sincerely,

John Durant, Director

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