HQ 228969 - Bayer Corporation; foreign trade zone; accounting for the raw materials; calculation of waste. - United States International Trade Commision Rulings

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HQ 228969

September 27, 2002

FOR-2-05 RR:CR:DR
228969 RDC

Category: FOREIGN TRADE ZONE

Kenneth G. Weigel
Laura Fraedrich
Alston and Bird
601 Pennsylvania Ave, N.W.
North Building
Washington, D.C. 20004

RE: Bayer Corporation; foreign trade zone; accounting for the raw materials; calculation of waste.

Dear Mr. Weigel and Ms. Fraedrich:

This is in response to your submission dated September 25, 2000, in which you requested a ruling on behalf of your client, Bayer Corporation, (“Bayer”), regarding accounting for the raw materials and the calculation of waste at its foreign trade subzone. We have also received your additional correspondence dated May 8, 2001; January 30, 2002; March 15, 2002; April 9, 2002; April 16, 2002, and September 5, 2002.

Bayer requested confidential treatment for certain information in the submissions made by it in this matter. Confidential treatment is granted, under 5 USC § 552(b)(4) and 19 CFR Part 103, for the information for which Bayer specifically requested such treatment; all such information is identified in its submissions. None of the information for which confidential treatment was requested is included in this ruling.

FACTS:

In its September 25, 2000, request Bayer states that it is requesting Customs approval “to use the chemical formula for its finished product to allocate raw material usage to that product” in its foreign-trade subzone, (“FTZ”). Bayer further explains its proposal in its March 15, 2002, submission,
instead of allocating raw material based on a ratio using a fixed quantity of waste, Bayer will allocate raw material to the finished product based on the chemically known amount of raw material in the finished product. All other raw material needed to manufacture the finished product is unrecoverable and valueless waste.

The following facts are based solely on Bayer’s representations contained in its submissions.

Bayer operates a FTZ in South Carolina and produces four chemicals from imported and domestic raw materials in that subzone. Some of the foreign raw materials used are privileged foreign merchandise and others are non-privileged foreign merchandise. The raw materials used are benzothiazole (“BT”), benzoyl chloride (“BCI”), NaMBT, DCHA, CHA, 4-ADPA and MIBK. These raw materials enter the subzone in tank containers and are then stored until they enter the production process. The tank containers are tracked through direct identification; each container is identified so it can be directly linked to a FTZ admission. The raw materials enter the production storage tanks one container at a time and the raw material inventory in the storage yard is relieved based on the direct identification accounting method. Because the foreign and domestic raw materials are fungible, after the raw materials enter the production storage tanks they are tracked using a first-in first-out method.

The amount of raw materials used daily is determined from tank gauges. The amount of materials used in a given day is calculated by comparing the tank levels to the previous day’s levels. Due to the nature of the level indicators on the storage tanks and the raw materials themselves, these tank measurements are not precise – the volume is affected by such things as atmospheric pressure and temperature. Bayer states that, as a result of this imprecision, different amounts of raw materials can be indicated as being used to produce the same amount of finished product because of atmospheric pressure and temperature, but the differences average out over time. Further, the amount of raw material consumed in the production process fluctuates as a result of efficiencies and yields.

Bayer produces four chemicals in the subzone: DBD; Vulkacit DZ (DZ); Vulkacit CZ (CZ); and Vulkanoz 4020 (4020). According to Bayer’s April 16, 2002, submission, the purity specifications for all four of these chemicals is less than 100 percent. There are three production outputs: 1) finished product; 2) re-feedable off-spec product (ROS); and 3) waste. 1) Finished product is fit for delivery to customers. The finished product is weighed daily. It is finished product that is entered from the FTZ into U.S. Customs territory. 2) ROS is product that must be re-worked in order to meet specifications, therefore it is re-fed into the production process. ROS is discussed below. 3) Three forms of waste are produced during the production process: liquid waste from CZ and DZ production only; scrap from all production; and waste materials in waste water from DBD, CZ and DZ production.

Liquid waste is a liquid, tar-like substance that is a byproduct of the productions process of CZ and DZ only. Currently, the amount of liquid waste produced in a given production run is not physically measured; liquid waste is not weighed or collected in a measuring vessel. Rather, a formula is used to determine how much liquid waste is generated by production. In the production of CZ, liquid waste is calculated at 1 percent of the total of finished product, ROS and scrap produced. For DZ, liquid waste is calculated at 12.8 percent of the total of finished product, ROS, and scrap produced. Bayer does not explain why the amount of liquid waste is calculated in this manner nor why it is not physically measured. Liquid waste is stored within the subzone until destroyed. It is not clear whether the liquid waste is destroyed within or without the subzone.

Scrap consists of floor sweepings and is generated for each of the four finished products. The scrap is collected and stored in the subzone until destroyed. The amount of scrap produced is determined by weighing the floor sweepings daily. The waste in waste water results from the use of water in the production process of DBD, CZ and DZ. This waste includes some of raw materials used to make these products. Bayer states that the waste water is treated at a water treatment plan at its Bushy Park facility. Bayer does not state whether this plant is inside or outside the FTZ or what happens to the waste water after it is treated.

ROS is weighed daily, labeled and dated. ROS production is recorded and retained in the inventory as the raw materials used to produce it, based on an allocation by weight method. The raw materials are then considered consumed when the ROS is re-fed into the production process. The calculated quantity of raw materials associated with the production of each lot of ROS has remained associated with that lot of ROS until the ROS is re-fed, but the ROS has not been considered to have consumed any specific (i.e., UIN) raw material until it was re-fed, resulting in the production of finished product. Bayer notes that this specific identification of ROS has “caused problems” and will be discontinued “with no adverse effect on the inventory control system.” ROS will still be tracked but, the raw material used to produce the ROS will be based on the chemical formula and will be maintained in the system as raw material for future use.

Bayer’s current system determines the amount of raw materials in four production outputs: finished product, ROS, and scrap and liquid waste on a relative proportion basis, comparing raw materials used in a given time period to output produced in the same period. The amount of finished product, ROS and scrap produced is determined by weighing these outputs. As stated above, the amount of liquid waste is calculated with a formula based on which chemical is being produced. A computer program then allocates raw material usage among these four outputs, on a first-in first-out basis, proportionately. Waste water is not accounted for. It is this allocation of raw materials as a percentage of total output which Bayer proposes to change. Also, the new method would not differentiate among scrap, liquid waste and waste water.

The three different types of waste generated, scrap, liquid waste, and waste in the waste water will no longer be treated separately. All waste will be grouped together. This waste will be determined only by subtracting the day’s finished product and ROS from the day’s total raw materials used – whatever raw material used is not accounted for in the day’s finished product or ROS will be considered waste. Scrap or floor sweepings will no longer be weighed; liquid waste will no longer be calculated as a percentage of total output; waste in the waste water was not accounted for under the old method but will be accounted for in the new method.

Bayer states that, with each weekly U.S. Customs entry, Bayer will report this waste amount to U.S. Customs using a moving average based on current usage data to avoid any aberrations resulting from tank content measurement. The cumulative usage is currently calculated monthly in conjunction with the closing of the accounting system. At year end, the final usage will be determined and any revisions necessary will be filed with Customs as part of the annual subzone reconciliation.

Customs Office of Laboratories and Scientific Services has reviewed the submission from Bayer regarding the calculation of waste in its FTZ. The lab has concluded that Bayer’s statement, that a certain, finite amount of raw material is contained in the chemical products and this amount of raw material is a constant based on the chemical formula for the product and its purity specification is technically accurate. The lab also agrees that for each of the finished products there is a unique chemical reaction that transforms the raw materials into the final product, and the amount of raw material contained in the finished product is a constant based on the chemical formula and the purity specification is for that finished product. With regard to the amount of raw materials contained in the finished products, the lab has reviewed the table found on page 3 of Bayer’s March 15, 2002, submission and find that the “Laws of Chemistry (Content)” column accurately shows the correct amount of raw material contained in one hundred pounds of the finished product if the finished product is 100 percent pure. Finally we note that Bayer’s statements that all waste produced is irrecoverable is factually incorrect. Since liquid waste and scrap are stored until destroyed they are obviously recovered and Bayer’s assertion that all waste produced is unrecoverable is not factually correct. Clearly, the liquid waste and scrap can be recovered in the common usage of the term recoverable. Bayer also states that it is not able to measure or track all waste on a physical basis – some waste goes into the waste water. Bayer states only that some of its raw materials are in the waste water which is subsequently treated. It is unknown whether the materials in the waste water are separated from that water when it is treated.

ISSUE:

Is Bayer’s proposed method of using the chemical formula for its finished product to allocate raw material usage to that product acceptable under the statute (19 USC § 81c(a)) and regulations (19 CFR § Part 146)?

LAW AND ANALYSIS:

As we understand Bayer’s request, it seeks approval of a new method of determining how much of the raw material used in its FTZ is in the finished product which is entered into U.S. Customs territory, and how much of the raw material used is waste, which is valueless (though not irrecoverable as explained above). Bayer contends that using the chemical formulas for its products to determine how much of the raw material is in the finished product and how much waste is generated is more precise that its current method.

Specifically,

Bayer requests Customs to rule that it may allocate raw material to the finished products entering U.S. Customs territory from its FTZ subzone based on the chemical formula for that finished product. Only the raw material as specified by the chemical formula appears in the finished product. All other raw material used to produce the finished product is non-dutiable waste.

Bayer states that the system it proposes does not affect the identification of the raw materials as domestic or foreign nor the dutiable status of the finished product as it is entered from the foreign trade subzone. Bayer further contends that it is not requesting the use of a new accounting method; that it will continue to identify the raw materials using a direct identification method while the merchandise is in the storage yard and a FIFO method when the raw materials enter the production process, with the exception relating to ROS specified below, and no changes in the way it identifies foreign and domestic merchandise will be made.

Bayer states that it must know the exact quantity of the different raw materials contained in the finished products and can measure the amount of raw materials used; therefore Bayer proposes to designate the difference between the amount of raw materials used and the amount of raw materials in the finished product - per the chemical formula for that product - as waste. Further, Bayer contends that it will pay duty only on the raw materials that leaves the FTZ in the finished product; all other raw material usage will be non-dutiable waste.

Bayer states that, based on the laws of chemistry, a certain finite amount of raw material must be present in a fixed amount of each finished chemical product. One chemical reaction transforms the raw materials into the final chemicals based on a fixed chemical formula. Further, although the amount of raw material consumed in the production process fluctuates because it is a function of efficiencies and yields, the amounts of raw material contained in the finished product and thus entered into Customs territory and dutiable is fixed by chemical formula. Hence, raw material consumed but not in the merchandise leaving the subzone will be considered waste. According to Bayer, all waste generated in the subzone is valueless.

The Foreign Trade Zones Act of 1934, as amended (48 Stat. 998; 19 USC § 81a through 81u) regulates the creation and operation of FTZs. Per 19 USC § 81c(a), in part,

Foreign and domestic merchandise of every description, except such as is prohibited by law, may, without being subject to the customs laws of the United States, except as otherwise provided in this chapter, be brought into a zone and may be . . . , mixed with foreign or domestic merchandise, . . . be manufactured except as otherwise provided in this chapter, and be exported, destroyed, or sent into customs territory of the United States therefrom, . . . but when foreign merchandise is so sent from a zone into customs territory of the United States it shall be subject to the laws and regulations of the United States affecting imported merchandise . . . .

Thus, 19 USC § 81c(a) provides that Bayer may bring the foreign and domestic chemical raw materials into its subzone without such chemicals being subject to U.S. customs law. While in the FTZ the chemical raw materials may be mixed with foreign or domestic merchandise and manufactured. When Bayer’s foreign merchandise is sent into the U.S. customs territory from its subzone, it is then subject to U.S. laws, including regulations affecting imported merchandise and assessment of import duty.

But, 19 USC § 81c(a) further states,

Provided, That whenever the privilege shall be requested and there has been no manipulation or manufacture effecting a change in tariff classification, the appropriate customs officer shall take under supervision any lot or part of a lot of foreign merchandise in a zone, cause it to be appraised and taxes determined and duties liquidated thereon.

This first proviso of 19 USC § 81c(a) therefore, authorizes privileged foreign merchandise status. Section 146.41(a), Customs Regulations (19 CFR § 146.41(a)), provides that, for purposes of foreign trade zones,
foreign merchandise which has not been manipulated or manufactured so as to effect a change in tariff classification will be given status as privileged foreign merchandise on proper application to the district director.

Such merchandise is called privileged foreign (“PF”) merchandise (19 CFR § 146.41). But for waste, privileged foreign merchandise retains its original identity even if it later goes through a manufacturing process (19 CFR § 146.41(e)). PF merchandise is classified and valued as provided in 19 CFR § 146.65.

19 USC § 81c(a) further provides,

If merchandise so taken under supervision [PF merchandise] has been manipulated or manufactured, such duties and taxes shall be payable on the quantity of such foreign merchandise used in the manipulation or manufacture of the entered article. Allowance shall be made for recoverable and irrecoverable waste; and if recoverable waste is sent into customs territory, it shall be dutiable and taxable in its condition and quantity and at its weight at the time of entry.

(Emphasis ours.) This portion of the FTZ Act must be read in conjunction with the preceding portion. The first words of this portion (underlined above) make it clear that this section applies to privileged foreign merchandise. Thus, it provides that when privileged foreign merchandise has been subject to manufacture or manipulation duty is owed on the amount of PF merchandise used in the manufacture of the entered merchandise and allowance must be made for waste. Therefore, the correct application of the proviso cited by Bayer is: when, as in Bayer’s case, PF merchandise is used in a manufacture, duty is due on the amount of privileged foreign merchandise used in the manufacture of the entered chemicals with an allowance for waste. This proviso applies only to privileged foreign merchandise, not to all raw material as Bayer states.

The legislative history to the 1950 amendment to the Foreign Trade Zones Act supports the foregoing reading of the statute. Prior to 1950, manufacturing within a foreign trade zone was prohibited. In 1950 the Act was amended to permit manufacturing. In doing so, the Senate Report explained the first proviso to section 3 of the FTZ Act:

Under the amended proviso, if foreign merchandise taken under supervision for the liquidation of duties and determination of taxes thereon is subsequently manipulated or manufactured, such duties and taxes would be payable on the quantity of such foreign merchandise used in the manipulation or manufacture of the article later sent into customs territory. Allowance would be made for recoverable and irrecoverable waste; and if recoverable waste were sent into customs territory, it would be dutiable and taxable in its condition and quantity and at its weight at the time of entry. Where two or more products resulted from the manipulation or manufacture of such merchandise the liquidated duties and determined taxes would be distributed to the several products in accordance with their relative value at the time of separation, with due allowance for waste as indicated above.

(S. Rep. No. 1107, 81st Cong., 1st Sess., reprinted in 1950 U.S. Code Cong. & Admin. News 2533, 2536.) Hence, duty is due on the amount of privileged foreign merchandise used in the manufacture of the entered chemicals with an allowance for waste. Bayer uses imported and domestic raw materials in its subzone. Some of the foreign raw materials used are privileged foreign merchandise and others are non-privileged foreign merchandise.

Bayer states that the “Goodman Manufacturing [69 F.3d 505, (CAFC 1995)] court decision is consistent with our view that raw material imported by Bayer should be attributed to the finished product based on the chemical formula for the finished product.” We do not agree with Bayer’s assertion that the court’s decision in Goodman Manufacturing v. United States, is consistent with Bayer’s proposal to attribute raw material usage based on the chemical formula for the finished product. The decision in Goodman Manufacturing is neither consistent nor inconsistent with Bayer’s procedures proposal; Goodman Manufacturing is simply immaterial to Bayer’s contention.

At issue in Goodman Manufacturing was the value of scrap steel which was a byproduct of manufacturing furnaces from Korean steel sheets in a foreign trade subzone. The Court of Appeals for the Federal Circuit itself stated, “[t]the issue is whether the Court of International Trade correctly held that the allowance for recoverable waste provided for in section 81c equals the value of the waste” (69 F.3d 505, 507). The value of its waste is not at issue in Bayer’s case; Bayer’s request, as we understand it, pertains only to the calculation of the quantity of waste and in no way pertains to the value of the waste.

Bayer also quotes the Goodman Court’s statement regarding the language of §81c(a), “[t]he phrase ‘allowance shall be made’ simply does not indicate any particular method” (id. at 509) as support for its position. However, the method the Court was referring to in this statement is the method for valuing the scrap, not the method for determining the quantity of the scrap. In footnote four, dicta, the Goodman court states that irrecoverable waste “would be accorded an allowance of full value” (id. at 512). Bayer interprets this statement to mean that “the value of the raw material in the irrecoverable waste is not to be included in the value of the product leaving the zone.” Bayer reasons that since the “chemical formula defines the exact amount of raw material that exists in the finished product” all the other raw material, per Goodman, is irrecoverable waste which is not subject to duty.

Even if Bayer’s interpretation of footnote four’s meaning is correct, it has been shown that at least some of the waste in Bayer’s subzone is recoverable. Moreover, as stated above, we do not here rule on any method of calculating the value of waste, only on a method of calculating the amount of waste. Finally, all raw materials used in a FTZ are not dutiable in the same manner, thus Bayer’s assertion is too broad as it cannot describe all raw materials used in a FTZ.

The Foreign Trade Zone Act provides that, "when foreign merchandise is so sent from a zone into the customs territory of the United States it shall be subject to the laws and regulations of the United States affecting imported merchandise" (19 USC § 81c(a)(1993)). Removal of merchandise from a FTZ is subject to the provisions in the Customs Regulations. Under 19 CFR § 146.62 and § 146.63, entry is required for foreign merchandise which is to be imported into the U.S. It is then subject to U.S. laws, including assessment of import duty and regulations affecting imported merchandise. It is a basic concept of customs law that articles which are imported into the United States are classified and duty is assessed on the basis of their condition when they are imported into the United States, (United States v. Citroen, 223 U.S. 407, 414-415 (1911), and cases cited therein; see also Simod America Corp. v. United States, 872 F. 2d 1572, 1577 (Fed. Cir. 1989)).

Thus, nonprivileged foreign status (NPF) merchandise is dutiable as entered. Nonprivileged foreign status is a residual category for merchandise which does not have privileged or zone-restricted status (19 CFR § 146.42). Also included in NPF status is waste from the manufacture of PF merchandise and certain domestic merchandise. Under § 146.65(a)(2) of the Customs Regulations (19 CFR § 146.65(a)(2)), nonprivileged foreign status merchandise (see 19 CFR § 146.42(a)) is subject to tariff classification in accordance with its character, condition and quantity as constructively transferred to Customs territory at the time the entry or entry summary is filed with Customs. Under this provision, the importer chooses to have the merchandise characterized, for tariff purposes, in its condition as removed from the zone.

Hence, the NPF status raw materials used by Bayer will be dutiable in accordance with their character, condition and quantity at the time the entry, i.e., as the finished products, DBD, DZ, CZ, and 4020. The amount of NPF raw material used in the manufacture of the finished chemicals is irrelevant, as is the amount of waste. Therefore, Bayer’s proposed method of using the chemical formula for its finished product to allocate raw material usage to that product cannot be applied to NPF status raw materials. Consequently, since all raw material processed in the subzone is not treated the same way for duty assessment purposes, Customs cannot approve Bayer’s proposal “to use the chemical formula for its finished product to allocate raw material usage to that product.”

Privileged foreign merchandise is an exception to the general rule that duty is assessed on the basis of a good’s condition when it is imported into the United States. Under 19 CFR § 146.65(a)(1), PF merchandise is subject to tariff classification according to its character, condition, and quantity, at the rate of duty in force on the date of filing, in complete and proper form, the application for privileged status (C.S.D. 86-4 (September 24, 1985)). 19 CFR § 146.41(e) provides that merchandise under privileged foreign status remains under that designation even if physical changes have occurred through a manufacturing process (C.S.D. 79-464 (June 5, 1979)). The only exception to this rule is, as stated above, waste from PF merchandise is considered nonprivileged foreign merchandise under 19 CFR § 146.42(b).

Accordingly, Bayer’s raw materials which are granted privileged foreign status will be classified, upon entry of the finished chemicals, under the subheading applicable to the raw material - not the finished chemical and will be dutiable at the rate which was in effect for that subheading when the application to obtain privileged foreign status was filed in complete and proper form. Thus, for example, DBD entered from the subzone and made from only privileged foreign BT and privileged foreign BCI is dutiable according to its tariff classification, character, condition, and rate of duty as determined when privileged status was conferred. The BT and BCL are dutiable as if no manufacturing took place, i.e., as BT and BCI not as DBD. Further, per 19 USC § 81c(a), duty is due on the quantity of PF merchandise used in the manufacture of the DBD with an allowance for waste.

In its FTZ Bayer determines the amount of raw materials used daily by tank gauges; the amount of materials used in a given day is calculated by comparing the tank levels to the previous day’s levels. Thus, identifying the raw materials using FIFO, Bayer can determine how much PF merchandise goes into the manufacturing process. Bayer’s current system determines the amount of raw materials in four production outputs on a relative proportion basis, i.e., allocating raw materials used in a given time period as a percentage of total output produced in the same period. However, liquid waste is not measured, its amount is calculated with a formula and the waste in waste water is not accounted for at all.

Bayer argues that Customs “has recognized that it is appropriate to use a formula to determine the content of a product” based on duty apportionment as applied to manufacturing substitution drawback. However, the method by which duty is apportioned for manufacturing substitution drawback is inapplicable in the FTZ context. 19 USC § 1313(b) permits substitution of merchandise for manufacturing drawback, substitution is not permitted in FTZs.

Bayer proposes to use the chemical formula for the products to determine the amount of raw material in the products leaving the subzone, and consequently the amounts of waste produced in the production process. Waste produced from the manufacturing process in the subzone can be calculated as follows. Bayer’s manufacturing operation results in three outputs: finished chemicals, ROS and waste. The amount of finished chemical is determined by weight. The amount of ROS is determined by weight. The Customs lab agrees that the raw material that is not incorporated into the finished product – when 100 percent pure - is either valueless waste or re-feedable off-spec (“ROS”) product.” Therefore, since the amount of raw materials used, total finished product produced and total ROS produced are known amounts (as determined by weight) the amount of waste produced in a given time can be calculated by subtracting the amount of finished product and ROS from total raw materials used.

Thus, since the Customs’ lab agrees that the amount of raw material contained in the finished chemicals when 100 percent pure is fixed based on the chemical formula, the exact amount of raw material in the finished chemical can be determined from its chemical formula and the waste allowance for PF merchandise can be calculated. However, none of the specifications for Bayer’s four chemicals considered here require 100 percent purity; all four chemicals will be considered finished product at certain, stated levels of purity below 100 percent. Therefore, in any given amount of these finished chemicals there will be impurities, and the presence of these impurities decrease the amounts of raw materials that must be in the finished product. Hence, to account for impurities in its finished product Bayer must reduce the amount of raw materials contained in the finished product.

Section 146.48 of the Customs Regulations (19 CFR § 146.48) implements 19 USC § 81c with respect to the entry of articles derived entirely or in part from nonprivileged foreign merchandise. Except for any privileged merchandise contained in the article, the section provides that the article is classified and appraised in accordance with its character and condition as entered from the zone (see C.S.D. 82-29). Any privileged merchandise content is dutiable as liquidated when the privileged status was granted (C.S.D. 79-464). Accordingly, when a finished product is produced from a combination of PF and NPF merchandise, such a product is first assessed duty based on its characteristics as entered, to account for the NPF merchandise. Then, the amount of PF merchandise used in the manufacture is calculated and deducted.

Finally, this ruling is based on the assumption that this method of calculating the amount of privileged foreign raw material based on the chemical formula and purity specification for the finished product is used consistently by Bayer for all other accounting purposes, and not exclusively for calculations required by Customs. Further, we note that this ruling has no application whatsoever to the valuation of waste in a FTZ.

HOLDING:

The chemical formula for the finished product leaving the FTZ may be used to determine the quantity of privileged foreign raw materials contained in the finished product provided that if the finished product is less than 100 percent pure, the amount of impurities in the finished product is taken into account.

Sincerely,

Myles Harmon, Acting Director

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