HQ W563557 - Valuation of Defective and Repaired Disc Drives; - United States International Trade Commision Rulings

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HQ W563557

December 26, 2006

RR:CTF:VS 563557 GG

CATEGORY: VALUATION

Mr. Erik Bikers
ITA Programs Manager
Seagate Technology LLC
920 Disc Drive
Scotts Valley, CA 95066

RE: Valuation of Defective and Repaired Disc Drives;

Dear Mr. Bikers:

This is in response to your ruling request, dated August 8, 2006, on the subject of the correct appraisement of hard disk drives that Seagate Technology LLC (“Seagate”) imports.

FACTS:

Seagate is a manufacturer of hard disc drive products also known as rigid disc drives. The company categorizes its products into the following product family groups:

Enterprise Storage (ES) – products that are used in enterprise servers, mainframes, and workstations; Personal Storage (PS) – products used in personal computers, including consumer electronic products (such as digital video recorders, gaming platforms, and digital music players); Notebook Storage (NS) – products used in mobile computing applications (i.e., in notebook computers).

The standard cost of ES products varies from $70 to $115; of PS products from $30 to $84; and of NS products from $30 to $61.

Seagate also designs, develops, and produces components that comprise the foundation for its storage products, and produces magnetic recording heads and rotating media that are enabling technologies for advanced storage devices, disc drives, and tape drives.

Seagate provides repair services for its drives that are under warranty at no charge to its customers. Generally, if a product is outside of the warranty period, Seagate does not service it, or it charges the customer for out of warranty services. The customer retains ownership of the item throughout the entire process. There are two levels of repairs: backend testing and repair, and clean room repair. The former involves basic repairs of a defective drive. Successfully repaired drives are returned to a distribution center to support future warranty replacements. If the drive does not pass the backend test it is sent to a clean room repair facility. Clean room repairs are usually more complex and may entail dismantling the drive. Drives that are not repairable are scrapped at standard cost.

To facilitate the repairs of its products sold to customers around the world, Seagate maintains collection points in various countries. After obtaining a return merchandise authorization from Seagate, customers are instructed to send products needing repair to the nearest collection point. The collection point consolidates the returned products and ships them to the nearest distribution center. The distribution center ships the defective products to be tested and repaired to an appropriate repair facility based on the family of the product to be repaired, what region the defective product is from, and what level of repair is required. The repair facilities are not related to Seagate, and are located in Reynosa, Mexico, and Penang Malaysia. The distribution centers also maintain buffer stock of refurbished or repaired products to support customer exchanges.

All defective drives that are to be repaired in Reynosa are first imported into the United States and sent to the repair provider’s facility in McAllen, Texas for processing before being sent on to Mexico. Once repaired, the repair facilities send the products to the appropriate distribution center within their respective region. Some of the repaired products are returned to customers in the United States.

ISSUE:

What is the appropriate method of appraisement for 1) the products returned initially to the United States for repair and 2) the repaired products that are returned to the United States for distribution to customers?

LAW AND ANALYSIS:
a. Products returned initially to the United States for repair

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 (TAA; 19 U.S.C. § 1401a). The preferred method of appraisement is transaction value, which is defined as the “price actually paid or payable for merchandise when sold for exportation to the United States,” plus five statutorily enumerated additions. 19 U.S.C. § 1401a(b)(1). The hard disc drive products are returned to the United States for processing in Texas before being sent on to a repair facility in Mexico. Their importation is not the result of a sale to Seagate, and thus, there is no sale for exportation to the United States. Consequently, the subject merchandise cannot be appraised on the basis of transaction value.

When transaction value is eliminated as the appropriate appraisement method, imported merchandise must then be appraised in accordance with the remaining methods of valuation, applied in sequential order. 19 U.S.C. § 1401a(a)(1). The alternative bases of appraisement, in order of precedence, are: the transaction value of identical or similar merchandise (19 U.S.C. § 1401a(c)); deductive value (19 U.S.C. § 1401a(d)); computed value (19 U.S.C. § 1401a(e); and the “fallback” method (19 U.S.C. § 1401a(f)).

The transaction value of identical or similar merchandise is based on sales, at the same commercial level and in substantially the same quantity, of merchandise exported to the United States at or about the same time as that being appraised. Seagate indicates that this valuation method does not apply because it does not sell identical or similar defective drives in the United States. We note that even if Seagate were to make such domestic sales, the resulting price information might have more relevance to an appraisement under deductive value than to one under the transaction value of identical or similar merchandise. Nevertheless, in this case we assume there are no sales to the United States of identical or similar defective drives made at or about the same time as the merchandise imported. Thus it is not possible to appraise on the basis of the transaction value of identical or similar merchandise.

Under the deductive value method, imported merchandise is appraised on the basis of the price at which it or identical or similar merchandise is sold in the United States in its condition as imported and in the greatest aggregate quantity either at or about the time of importation, or before the close of the 90th day after the date of importation. 19 U.S.C. § 1401a(d)(2)(A)(i)-(ii). This price is subject to certain enumerated deductions. 19 U.S.C. § 1401a(d)(3). The imported merchandise is not sold in the United States in its condition as imported, nor do there appear to be any such sales of identical or similar products. Accordingly, the merchandise cannot be appraised under the deductive value method.

Under the computed value method, merchandise is appraised on the basis of the material and processing costs incurred in the production of imported merchandise, plus an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind, and the value of any assists and packing costs. 19 U.S.C. § 1401a(e)(1). Seagate advises that while it would be able to determine the standard cost for a particular product when new, it does not track the age or the original selling price of a particular drive. Consequently, the computed value method is also unavailable.

When merchandise cannot be appraised under the methods set forth in 19 U.S.C. § 1401a(b)-(e), its value is to be determined in accordance with the “fallback” method set forth in section 402(f) of the TAA. The fallback method provides that merchandise should be appraised on the basis of a value derived from one of the prior methods reasonably adjusted to the extent necessary to arrive at a value. 19 U.S.C. § 1401a(f)(1). In this regard, Seagate proposes using the fallback method based on a computed value that would be adjusted to account for the defective nature of the goods. Specifically, it suggests appraising the defective goods at the average standard cost of a product (calculated at the product family level) less the average cost of repairing a product in that product family (i.e., ES, PS, and NS). The average standard cost of a product takes into account the cost of the materials, labor, and overhead for an average product in a product family. Seagate explains that as a product family consists of both older and newer products, by using an average standard cost for a product family, a deduction would not be needed for depreciation, as the ages of the products within a family will be averaged together. With regard to the repair cost, Seagate calculates an average repair value for each product family as that is the basis on which the repair facilities are compensated for the products they repair.

Seagate cites to several Headquarters Rulng Letters (“HQ”) to demonstrate that U.S. Customs and Border Protection (“CBP”) has approved similar fallback methodologies for other importers. Specifically, in HQ 548688, dated July 2, 2003, CBP allowed a protestant to appraise returned defective power supplies using a fallback method that was based on the standard cost of new units less the average repair cost. The standard cost was based on the cost of the parts, labor and other expenses associated with producing new units. In HQ 544377, dated September 1, 1989, CBP permitted the use of inventory value in the importer’s accounting records to appraise telephone equipment returned for repair. The inventory value was based on the standard cost of new equipment, which included costs of parts, labor and other expenses for producing the telephone equipment. The company assigned a seventy percent of standard cost value to the damaged equipment because the importer estimated that thirty percent was the average cost to have the damaged equipment repaired. More recently, in HQ 563407, dated April 13, 2006, CBP approved the use of the fallback method for imported used in-flight entertainment systems that were imported for repair. In that case appraisement was based on the unit cost of a new article less the average historical cost of repair percentage, calculated on a yearly basis.

There clearly are similarities between Seagate’s proposed method and the cited rulings. When asked the reason for electing to use the average standard cost of a product in a product family instead of the average standard cost of the product itself, Seagate in an e-mail message dated December 6, 2006 gave the following explanation:

Seagate has very many different product configurations that vary in cost depending upon customer requirements, and the ages of products within a product family range greatly too. The administrative burden for managing the depreciation deductions for each product would be onerous. Since the repair cost of a product is calculated at a product family level, utilizing an average standard cost of a product in a product family would provide a more direct correlation to the average repair value and ease the administrative burden.

Taken in its entirety, we find the method suggested by Seagate to be reasonable. Therefore, we approve Seagate’s proposal to appraise its imported defective drives at the average standard cost of a product in a product family less the average cost of repair in that product family pursuant to 19 U.S.C. § 1401a(f).
b. Repaired disk drives returned to the United States for distribution to customers

As stated above, the preferred method of valuation is transaction value, which is defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus five statutorily enumerated additions. 19 U.S.C. § 1401a(b)(1). The repair facilities never own the Seagate drives that are consigned to them for repair; rather, ownership remains with the Seagate customers who returned the drives for repair. The drives’ importation to the United States following repair thus cannot be categorized as being pursuant to a sale for exportation to the United States. The lack of a sale eliminates transaction value as a viable appraisement method.

The second appraisement method is the transaction value of identical or similar merchandise. This is based on sales, at the same commercial level and in substantially the same quantity, of merchandise exported to the United States at or about the same time as that being appraised. 19 U.S.C. § 1401a(c). Seagate indicates that it cannot use this method because, although it sells excess refurbished disc drives in the United States, such sales are not at the same commercial level or in substantially the same quantities as the imported refurbished drives. We think that this fact has little or no bearing on the transaction value of identical or similar merchandise method, but may be a factor in the possible use of deductive value instead. This will be discussed in the next paragraph. Absent any information on incoming shipments of identical or similar refurbished drives, however, we are precluded from appraising the imported refurbished disc drives under 19 U.S.C. § 1401a(c).

Deductive value, the third appraisement method, bases the appraisement of imported merchandise on the price at which it or identical or similar merchandise is sold in the United States in its condition as imported and in the greatest aggregate quantity either at or about the time of importation, or before the close of the 90th day after the date of importation. 19 U.S.C. § 1401a(d)(2)(A)(i)-(ii). Seagate claims that this method does not apply because it does not resell the refurbished drives that have been repaired under warranty. Seagate indicates, however, that it does sell certain imported excess refurbished drives to customers in the United States. Under deductive value, the domestic sale of merchandise that is identical or similar to the merchandise being appraised may qualify the goods for appraisal under this method. We have not been provided with sufficient information to determine here if this method might apply, because we do not know when the domestic sales occur or if they involve identical or similar disc drives. Since the valuation methods are applied in sequential order, however, the refurbished disc drives must be appraised under 19 U.S.C. § 1401a(d) if they are otherwise found to meet the requirements of that method.

Following a careful assessment, should it be determined that deductive value does not apply, then the next appraisement method is computed value. As noted earlier, under this method merchandise is appraised on the basis of the material and processing costs incurred in the production of imported merchandise, plus an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind, and the value of any assists and packing costs. 19 U.S.C. § 1401a(d). Seagate indicates that it does not possess the information required to use this method of appraisement. Specifically, the company says that it does not maintain the original selling price of the product that is being returned in a repaired state. That being the case, we agree that the refurbished disc drives cannot be appraised under computed value.

The remaining appraisement method is the fallback method, in accordance with 19 U.S.C. § 1401a(f). This method provides that merchandise should be appraised on the basis of a value derived from one of the prior methods, reasonably adjusted to the extent necessary to arrive at a value. Seagate proposes appraising the repaired products at the average standard cost for the product (based on the appropriate product family), which would account for the cost of the average new product’s material, labor, and overhead. As the product would not be imported in a new condition, but rather, in a refurbished one, Seagate explains that the average standard cost of a product would be greater than the market value of a refurbished drive. Although this proposed method is similar to the one approved with regard to the defective devices returned to the United States for repair, in our view there may be a fallback method that more accurately reflects the value of the refurbished drives. Specifically, 19 CFR § 152.107(c) provides that in arriving at a fallback value, the 90-day sale requirement that pertains to deductive value may be “administered flexibly.” As noted earlier, Seagate sells imported excess refurbished disc drives to U.S. customers. If such sales otherwise qualify for appraisal under deductive value except for the fact that they do not meet the 90-day requirement, then it is possible that they could be appraised under a modified deductive value under 19 U.S.C. § 1401a(f). This method would be preferable to the one proposed by Seagate because it would be product rather than product family specific. In the event, however, that after careful examination it is determined that a modified deductive value does not apply, then the merchandise may be appraised under the fallback method proposed by Seagate.

HOLDING:

The defective drives returned to the United States for repair may be appraised under the fallback valuation method, in accordance with the methodology proposed by the importer. The imported refurbished disc drives should be appraised using the deductive value method if, after review of all available information, it is apparent that they qualify under this method. If they do not so qualify, they should be appraised under the fallback method, using a modified deductive value, or, alternatively, the method proposed by the importer.

A copy of this ruling letter should be attached to the entry documents filed at the time this merchandise is entered. If the documents have been filed without a copy, this ruling should be brought to the attention of the Customs official handling the transaction.

Sincerely,

Monika R. Brenner
Chief, Valuation and Special Programs Branch

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