HQ 224227 - Internal Advice request concerning drawback claims; Lonestar Technologies, Ltd.; 19 U.S.C. 1313(c), 1313(j)(1), 1313(j)(2) - United States International Trade Commision Rulings

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HQ 224227

May 2, 1996

DRA-4/5-RR:IT:EC 224227 CC

CATEGORY: ENTRY

Maryanne Carney
Chief, Drawback Branch,
Port of New York
U.S. Customs Service
6 World Trade Center
Room 762
New York, NY 10048

RE: Internal Advice request concerning drawback claims; Lonestar Technologies, Ltd.; 19 U.S.C. 1313(c), 1313(j)(1), 1313(j)(2)

Dear Ms. Carney:

This is in response to your request for internal advice, dated September 30, 1992, concerning drawback claims made by Lonestar Technologies, Ltd. (Lonestar).

FACTS:

Lonestar, formerly Planned Technologies, Ltd., imports telephones, telephone answering machines, and karaoke music machines from manufacturers in the Far East. Lonestar also directs individual retailers, such as Target Stores and K Mart, to import the merchandise from Planned Technologies, Hong Kong (PTHK). Lonestar is the major stockholder for PTHK. The direct purchases that Lonestar makes from manufacturers are to maintain an inventory of replacement goods in the U.S. and to make domestic sales to companies.

Special arrangements have been made for the return of merchandise by Lonestar to the overseas manufacturers, for both direct purchases, where Lonestar is the importer of record, and where the retail chains are the importers of record. Thus Lonestar has agreed with the retail chains to take their returns, and Lonestar ships the returns back to the manufacturers. Lonestar has a "no-questions-asked" return policy, in which it does not inquire as to the reason for the return of the merchandise. Through Lonestar, individual retailers may exchange merchandise where it is defective, its packaging is damaged, or it has been returned to the stores by consumers for unspecified reasons.

When a retailer finds merchandise to be unsalable for any reason, it may send the merchandise to Lonestar. Lonestar will provide an even exchange using inventory imported directly from manufacturers. No records are maintained showing the reason for return. All returned merchandise is commingled, making no distinction between good, used, unused, broken, damaged or defective products. After consolidation, the goods are exported to the manufacturer.

Lonestar filed drawback claims under 19 U.S.C. 1313(j)(1). All claims designated only Lonestar imports. No certificates of delivery (CD) have been submitted by the retailers, although three companies have filed letters, waiving drawback and assigning drawback rights to Lonestar. Since many importers of record are involved, counsel for Lonestar has stated that the filing of CD's or waiver letters would be burdensome and has requested that its client be relieved of this requirement.

The New York Region Drawback Branch requested an audit of Lonestar's drawback claims in December 1991. The audit covered four drawback entries. Among the findings in the audit report, issued in September 1992, are that Lonestar's records did not fully support its claims for direct identification same condition drawback, same condition substitution drawback, and rejected merchandise drawback.

The four drawback entries the subject of the audit are unliquidated. Following the audit, your office made an internal advice request for the four entries. In May 1993, counsel for the claimant requested that its drawback claims be considered under 19 U.S.C. 1313(j)(1). In May 1994 counsel for the claimant requested that its claims be considered in light of the amendments to the drawback law. Also it was requested that the claims be considered under 19 U.S.C. 1313(j)(2).

ISSUE:

Whether the subject claims meet the requirements for drawback under 19 U.S.C. 1313(c), 19 U.S.C. 1313(j)(1), or 19 U.S.C. 1313(j)(2)?

LAW AND ANALYSIS:

The drawback law was substantially amended by section 632, title VI - Customs Modernization, Public Law 103-182, the North American Free Trade Agreement Implementation Act (107 Stat. 2057), enacted December 8, 1993. Title VI of Public Law 103-182 took effect on the date of enactment of the Act (section 692 of the Act). According to the applicable legislative history, the amendments to the drawback law (19 U.S.C. 1313) are applicable to any drawback entry made on or after the date of enactment as well as to any drawback entry made before the date of enactment if the liquidation of the entry is not final on the date of enactment (H. Report 103-361, 103d Cong., 1st Sess., 132 (1993); see also provisions in the predecessors to title VI of the Act; H.R. 700, 103d Cong., 1st Sess., section 202(b); S. 106, 103d Cong., 1st Sess., section 202(b); and H.R. 5100, 102d Cong., 2d Sess., section 232(b)). Since the drawback entries the subject of this request have not been liquidated, the amendments to the drawback law are applicable.

It has long been the position of Customs that drawback claimants must adhere to the requirements set forth in the applicable statutes and regulations to qualify for drawback. The courts have repeatedly upheld this position (see, e.g., Swan Tricot Mills Corp. v. United States, 63 Cust. Ct. 530, C.D. 3948 (1969); GAF Corporation v. United States, 72 Cust. Ct. 153, C.D. 4526 (1974); and United States v. Lockheed Petroleum Services, Ltd., 709 F.2d 1472 (Fed Cir. 1983)). We have found in application of the applicable statutes and regulations that sufficient records must be maintained in order to support a claim for drawback. See, e.g., HQ 223497 of July 2, 1992.

19 U.S.C. 1313(c)

The requirements under the amended section 1313(c) (merchandise not conforming to sample or specification) are the following:

1. The merchandise must:

(a) be not conforming to sample or specifications; or

(b) be shipped without the consent of the consignee; or

(c) be determined to be defective as of the time of importation;

2. Duties must have been paid upon the merchandise on which drawback is claimed;

3. The merchandise on which drawback is claimed must have been entered or withdrawn for consumption;

4. Within 3 years after release from the custody of the Customs Service, the merchandise on which drawback is claimed must have been returned to the custody of the Customs Service for exportation or destruction under the supervision of the Customs Service.

Thus the law with respect to rejected merchandise drawback was amended in three areas: 1) merchandise can now be destroyed as opposed to only being exported: 2) the time period for claiming drawback has increased from 90 days to 3 years; and 3) what constitutes rejected merchandise has been liberalized.

Regarding the issue of rejected merchandise, House Report 103-361, 103d Congr., 1st Sess., 129 states the following:

Section 632 amends the rejected merchandise drawback provisions ... to allow the importer and foreign supplier to agree that the imported merchandise was defective without reference to purchase specifications or samples. If the importer and foreign supplier could not agree that the merchandise was defective, Customs would be required to make that determination. Under Section 632, imported merchandise could be used for up to 3 years and the importer could get a duty refund if it was shown that the merchandise did not conform to specifications or sample or was defective at the time of importation.

Therefore, in order to qualify for rejected merchandise drawback, the claimant would need to provide evidence that either the imported merchandise did not conform to sample or specifications or the foreign supplier and Lonestar would have to agree that the imported merchandise was defective or the merchandise was defective at the time of importation. In addition, we note that 19 U.S.C. 1313(c) does not provide for substituting merchandise for drawback. Consequently, Lonestar must show that merchandise that it is importing on which it pays duty, is the same merchandise that is being exported; it cannot export merchandise that was imported by the retailers under 19 U.S.C. 1313(c).

Counsel for Lonestar claimed in its letter of May 1994 that House Report 103-361 provides that drawback rights are transferable, and would not limit the use of rejected merchandise drawback under section 1313(c) to the original importer. In addition, counsel noted that 19 U.S.C. 1313(t) contemplates that an importer will be able to issue a certificate which will enable another party to assume the importer's right to claim drawback.

Although the amended statute for rejected merchandise drawback does not specifically preclude a drawback claim for someone other than the original importer, regulations which were in effect prior to the amended law prohibited anyone other than the importer from claiming drawback under 19 U.S.C. 1313(c). Section 191.142(b)(6) of the Customs Regulations (19 CFR 191.146(b)(6)) provides, "Drawback under this section [Merchandise not conforming to sample or specifications or shipped without the consent of the consignee] is payable to the exporter-claimant who is the importer of record or the actual owner named in the import entry." In addition, the language of 19 U.S.C. 1313(c), as amended, has not changed to indicate that drawback can be claimed under this section by someone other than the importer. Although changes in the law regarding rejected merchandise are discussed in House Report 103-361, allowing drawback under 19 U.S.C. 1313(c) for someone other than the importer is not one of those changes. In addition, counsel argues that section 1313(t) contemplates that an importer will be able to issue a certificate which will enable another party to assume the importer's right to claim drawback. There is nothing in the statute or legislative history which shows that a drawback certificate could be issued from an importer to another party to claim drawback under 19 U.S.C. 1313(c). Although we note that Customs Regulations concerning drawback are being drafted in light of the amendments to the law, at this time we are unaware of any change in the law regarding who may make a drawback claim pursuant to 19 U.S.C. 1313(c).

19 U.S.C. 1313(j)

The requirements under the amended section 1313(j)(1) (direct identification unused merchandise drawback) are the following:

1. The merchandise on which drawback is claimed must have been imported;

2. A duty, tax, or fee imposed by Federal law because of the importation of the imported merchandise must have been paid;

3. The exporter (or destroyer) has the right to claim drawback but may endorse that right to the importer or any intermediate party;

4. The merchandise on which drawback is claimed must have been exported or destroyed under Customs supervision within 3 years of the date of importation; and

5. the merchandise on which drawback is claimed must not have been used (except as permitted under section 1313(j)(3) in the United states before the exportation or destruction.

The requirements under the amended section 1313(j)(2) (substitution unused merchandise drawback) are the following: 1. There must be imported merchandise on which was paid any duty, tax, or fee imposed under Federal law because of its importation;

2. The drawback claimant must have either:

(a) Imported the imported merchandise; or

(b) Received from the person who imported and paid any duty due on the imported merchandise a certificate of redelivery transferring to that party the imported merchandise, commercially interchangeable merchandise, or any combination thereof;

3. There must be other (substitute) merchandise which is:

(a) Commercially interchangeable with the imported merchandise; and

(Exported or destroyed under Customs supervision within 3 years of the date of importation of the imported merchandise; and

4. Before the exportation or destruction of the other (substitute) merchandise, that merchandise:

(a) May not be used (except as permitted under section 1313(j)(3) in the United States; and

(b) Must be in the possession (as described in the amended section 1313(j)(2)(C)(ii) of the person claiming drawback.

Both 19 U.S.C. 1313 (j)(1) and (j)(2) require that the merchandise on which drawback is claimed may not be used. A definition of the term unused merchandise was not provided in the language of the new act. In Customs Service Decision (C.S.D.) 81-222 and C.S.D. 82-135, however, it was found that an article is used when it is employed for the purpose for which it was manufactured and intended. In addition, 19 U.S.C. 1313(j)(3), as amended, provides that the performance of certain "incidental operations" (such as testing, cleaning, and inspecting) on the imported item, not amounting to a manufacture or production, is not treated as a use of the merchandise. Much of the merchandise has reached the ultimate consumer and was returned. In HQ 222633 of December 10, 1990 we found that if the ultimate consumer took household glassware home and discovered that it was defective, then the merchandise was considered to be used and 19 U.S.C. 1313(j) was not applicable. In, C.S.D. 84-100 of February 28, 1984, it was stated concerning use that if consumers tried to use cutlery and it would not perform, then 19 U.S.C. 1313(j) would apply, but if the cutlery were used more than incidentally with unsatisfactory results, that law would not apply. No final determination was made in that case due to insufficient information, e.g., whether the consumers were retailer-wholesale distributors or the ultimate users. In this case, although the audit found that some merchandise was returned by consumers who had not used the merchandise, it was also found that Lonestar did not maintain any records as to why the merchandise was returned to the retailer, nor has the extent of consumer use been documented by either the retailer or Lonestar in all cases. Since much of the merchandise has been used and that which has not cannot be documented by Lonestar, the requirement that the merchandise not be used under 19 U.S.C. 1313(j) has not been met.

In addition, under both 19 U.S.C. 1313(j)(1) and 19 U.S.C. 1313(j)(2) certificates of delivery are required. Section 191.141(b)(1) of the Customs Regulations (19 CFR 191.141(b)(1)) provides that an exporter-claimant filing drawback under 19 U.S.C. 1313(j) document all transfers by certificates of delivery in accordance with 19 CFR 191.65. The audit found that for the claims under review, Lonestar was not the importer of record, nor did it maintain certificates of delivery from the actual importers of record. Therefore, the requirement to document transfers by maintaining certificates of delivery has not been met by Lonestar.

Under 19 U.S.C. 1313(j)(2), as amended, the claimant must show commercial interchangeability. Prior to the amendments in the law, the standard for substitution was fungibility. We found under the prior law that defective or unacceptable merchandise is not fungible with designated merchandise that has not been shown to have the same defect to the same extent or unacceptable characteristic, and is not eligible for same condition substitution drawback. HQ 219941 of December 22, 1987.

According to House Report 103-361, which explains the change from fungibility to commercial interchangeability in the amended law, the new standard is intended to be made less restrictive (i.e., "the Committee intends to permit the substitution of merchandise when it is commercially interchangeable rather than when it is commercially identical.") The Committee also stated that in determining whether two articles are commercially interchangeable, the criteria to be considered would include, but not be limited to: Governmental and recognized industrial standards, part numbers, tariff classification, and relative values.

Under this commercial interchangeability standard, all the criteria would be met except for the relative value. The defective merchandise would have much less value than the functioning merchandise. If Lonestar were importing defective merchandise and exporting defective merchandise, or importing functioning merchandise and exporting functioning merchandise, then the merchandise would have the same relative value. But it appears that for the most part, Lonestar is importing functioning merchandise and exporting defective merchandise which would not have the same relative value. Even if there are cases where like merchandise of the same value is being imported and exported, the audit has revealed that Lonestar was not able to substantiate the reasons for return of the merchandise to the foreign supplier. Thus, Lonestar has not met the commercial interchangeability requirement of 19 U.S.C. 1313(j)(2).

Common requirements to 19 U.S.C. 1313(c), (j)(1), and (j)(2)

19 U.S.C. 1313(c), (j)(1), and (j)(2) all require that merchandise on which drawback is claimed be exported or destroyed within three years from the date of importation. In the audit it was found that because of the "no-questions-asked" return policy for consumers of the retailers, it is possible merchandise was returned after 3 years from the date of importation. Thus Lonestar has failed to provide evidence to show that its claims for drawback were made within the three year statutory period.

HOLDING:

Lonestar does not have adequate records to show that it has met the requirements for drawback under 19 U.S.C. 1313(c), 19 U.S.C. 1313(j)(1), or 19 U.S.C. 1313(j)(2) for the subject claims and, therefore, is not eligible to receive drawback.

The Office of Regulations and Rulings will take steps to make this decision available to Customs personnel via the Customs Rulings Module in ACS and to the public via the Diskette Subscription Service, Freedom of Information Act, and other public access channels within 60 days from the date of this decision.

Sincerely,

Director, International Trade

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