HQ H021426 - Treatment of Administrative Costs in Determining the Regional Value Content (“RVC”) of Pumps and Motors Assembled in Mexico Under the North American Free Trade Agreement (“NAFTA”) - United States International Trade Commision Rulings

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HQ H021426

April 2, 2008

OT:RR:CTF:VS H021426 JPP

CATEGORY: VALUATION

Ms. Sandra Liss Friedman
Barnes, Richardson & Colburn
475 Park Avenue South
New York, New York 10016

RE: Treatment of Administrative Costs in Determining the Regional Value Content (“RVC”) of Pumps and Motors Assembled in Mexico Under the North American Free Trade Agreement (“NAFTA”)

Dear Ms. Friedman:

This is in response to your letter dated December 13, 2007, on behalf of ITT Corporation (“ITT”) of White Plains, New York, in which you requested an advance ruling under the Appendix to Part 181, Customs Regulations (19 C.F.R. Part 181, App.; NAFTA Rules of Origin Regulations (“Rules of Origin”)), regarding the treatment of certain administrative costs in determining the regional value content (“RVC”) of a good under the North American Free Trade Agreement (“NAFTA”).

FACTS:

The merchandise at issue consists of finished pumps and motors that ITT, through its business unit Flojet (“ITT Flojet”), imports from Mexico. The pumps and motors are manufactured by an unrelated Mexican company, Grupo American Industries, S.A. de C.V. (“American Industries”), which provides ITT with contract assembly services under what is commonly referred to as “maquiladora shelter operation.” American Industries’ assembly operations devoted to the production of Flojet pumps and motors are located in Chihuahua, Mexico (“AI FJ”). You have advised that the imported pumps are classified under subheading 8413.50 of the Harmonized Tariff Schedule of the United States (“HTSUS”); and the motors are classified under subheading 8501.31, HTSUS.

Under the instant manufacturing arrangement, ITT Flojet retains ownership of materials, components, tools and machinery used in the production of the pumps and motors. The cost of these items is recorded on ITT Flojet’s books. American Industries maintains a separate office in Chihuahua, Mexico that provides administrative support to all its production facilities, including AI FJ’s. In preparing an individual operation’s financial and accounting records, American Industries determines the cost of the administrative support services attributed to each operation and records the expenses assigned to the individual operation on its books and records. Ultimately, these expenses are allocated to each manufacturing operation.

Production, overhead and labor costs associated with ITT Flojet products, including direct and indirect labor, direct and indirect factory overhead and operating costs, transportation, brokerage, duties and taxes, and general and administrative (“G&A”) expenses, are recorded on American Industries’ books. Included in the G&A expenses allocated by American Industries to the AI FJ assembly operations are costs which, while not directly production related, are incurred because of the contractual obligations undertaken by American Industries to effectuate the production of the subject merchandise. These expenses are more fully described as follows:

Administrative Labor

This account includes the office staff and management payroll costs of the American Industries administrative support office attributable to the AI FJ production facility.

Global Labor (Admin.)

This account includes the global labor benefits related to AI FJ’s Administrative Labor. The global labor benefits includes the company’s contribution to social security insurance, medical plan insurance, payroll taxes, employee housing program, and employee saving funds.

Shelter Fee

This account includes other G&A costs related to the operation and production activities of AI FJ and American Industries’ profit on its services to ITT Flojet. Specifically, the G&A costs include: human resource services, accounting and fiscal services, customs services, freight forwarding, environmental control, purchase of non-production goods and services and expatriate assistance.

In determining the NAFTA eligibility of the motors and pumps, American Industries and ITT Flojet propose to use the net cost method of calculating RVC.

Counsel submits that the above-referenced administrative expenses are recorded on American Industries’ books and incurred solely to support AI FJ maquiladora shelter operations and enable the goods to be delivered to the United States. Counsel requests confirmation that these costs, with the exception of the profit factor included in the Shelter Fee,

/ Counsel concedes that “total cost” does not include profits that are earned by the producer, as provided in Sec. 2(6) of the NAFTA Rules of Origin Regulations./ can be included in the calculation of “total costs” for purposes of determining RVC.

No cost information was furnished in connection with this ruling request. Therefore, the scope of this ruling is limited to the treatment of the specific expenses described above in determining RVC and does not address the NAFTA eligibility of the imported merchandise.

ISSUE:

Whether certain administrative expenses, which are recorded on American Industries’ books, may be included in the calculation of RVC for purposes of NAFTA eligibility.

LAW AND ANALYSIS:

Under Section 4 of the NAFTA Rules of Origin Regulations (19 C.F.R., Part 181, App., Sec. 4), a good originates in the territory of a NAFTA Party if it is “wholly obtained or produced” in accordance with Sec. 4(1), or if it satisfies the applicable change in tariff classification, the applicable RVC requirement or combination thereof under Sec. 4(2).

The appropriate change-in-tariff and RVC requirements for particular tariff headings are described in General Note (“GN”) 12, HTSUS. The NAFTA Rule of Origin for each of the goods at issue, i.e., motors and pumps, provides that the good will be considered to originate for NAFTA purposes if it satisfies: (a) a change in tariff classification; or (b) meets an alternative change in classification requirement and satisfies a RVC test. See GN 12(t)/84.25 and GN 12(t)/85.1, HTSUS. You have requested Customs and Border Protection (“CBP”) to use the second alternative rule of origin for each of these goods, i.e., the net cost method.

Regional Value Content Calculation

General Note 12(c), HTSUS, provides the methods for determining the RVC of a good for purposes of NAFTA. The net cost method is set forth in GN 12(c)(ii), HTSUS, and provides as follows:

The regional value content of a good may be calculated on the basis of the following net cost method:

RVC = (NC - VNM) / NC x 100

Where RVC is the regional value content, expressed as a percentage; NC is the net cost of the good; and VNM is the value of the non-originating materials used by the producer in the production of the good. See also, Sec. 6(3), Rules of Origin.

The methods of calculating the net cost of a good are set forth in Sec. 6(11), Rules of Origin. Subsection (11) provides three methods from which the producer of a good may choose to calculate the net cost, all of which involve the calculation of the producer's total cost. The methods are:

(a) calculating the total cost incurred with respect to all goods produced by that producer, subtracting any excluded costs that are included in that total cost, and reasonably allocating, in accordance with Schedule VII, the remainder to the goods;

(b) calculating the total cost incurred with respect to all goods produced by that producer, reasonably allocating, in accordance with Schedule VII, that total cost to the good, and subtracting any excluded costs that are included in the amount allocated to that good; or

(c) reasonably allocating, in accordance with Schedule VII, each cost that forms part of the total cost incurred with respect to the good so that the aggregate of those costs does not include any excluded costs.

Section 6(11), Rules of Origin.

Under the three methods set forth in Sec. 6(11), certain “excluded costs” need to be deducted from total cost in determining net cost. “Excluded costs” consist of “sales promotion, marketing and after-sales service costs, royalties, shipping and packing costs and non-allowable interest costs.” Sec. 2(1), Rules of Origin. Each of these aspects of “excluded costs” are further defined in section 2(1) of the Rules of Origin. / For example, Sec. 2(1) defines the phrase “sales promotion, marketing and after-sales service costs” to include excluded costs, such as:
salaries and wages, sales commissions, bonuses, benefits (for example, medical, insurance, pension), traveling and living expenses, membership and professional fees, for sales promotion, marketing and after-sales service personnel;

(d) recruiting and training of sales promotion, marketing and after-sales service personnel, and after-sales training of customers’ employees, where such costs are identified separately for sales promotion, marketing and after-sales service of goods on the financial statements or cost accounts of the producer; . . .

Sec. 2(1), Rules of Origin./
Furthermore, in calculating net cost, any costs that are a part of total cost and need to be allocated to the goods must be allocated in accordance with Schedule VII (Reasonable Allocation of Costs), Rules of Origin.

Calculation of Total Cost

The calculation of net cost initially requires the proper calculation of the “total cost.” Section 6(12) provides that “total cost” is calculated in accordance with Sec. 2(6) of the Rules of Origin which state that “total cost” consists of all product costs, period costs and other costs that are recorded, except as otherwise provided (e.g., in the case of materials and intermediate materials) on the books of the producer. Sec. 2(6), Rules of Origin. The term “product costs” is defined as “costs that are associated with the production of a good, and includes the value of materials, direct labor costs and direct overhead”; the term “period costs” is defined as “costs, other than product costs, that are expensed in the period in which they are incurred.” Ibid., Sec. 2(1). “Other costs,” with respect to total cost, are defined as “all costs that are not product costs or period costs.” Id.

Total cost, therefore, is determined on the basis of the expenses recorded on the books of the producer, except in the case of materials and intermediate materials, whose value is determined, respectively, in accordance with other sections in the Rules of Origin. For NAFTA purposes, the term "producer" is defined as “a person who grows, mines, harvests, fishes, traps, hunts, manufactures, processes or assembles a good.” Sec. 2(1), Rules of Origin. Based on this definition and the information provided in the Facts section above, we determine that American Industries is the producer of the subject merchandise within the definition of Sec. 2(1).

In prior rulings, CBP has considered the treatment of producer’s costs in the calculation of RVC under the NAFTA. In Headquarters Ruling Letter (“HRL”) 545675, dated April 28, 1995, CBP considered the treatment of indirect labor costs, factory overhead and operating costs in the calculation of RVC under the net cost method. CBP concluded that those costs could be included as part of the net cost of the imported electronic products, provided that they were recorded on the books of the producer. See also HRL 545635, dated November 29, 1994 (finding that because the expenses were not recorded on the producer’s books as required by the Rules of Origin, they could not be included in the calculation of the producer’s total cost); and HRL 547881, dated August 27, 2001 (finding that only the product costs, period costs and other costs recorded on the Mexican producer’s books may be included in the calculation of total cost).

Clearly, HRLs 545675, 545635 and 547881 emphasized that only the costs on the books of the producer (i.e., recorded on the Mexican accounting books) are to be considered in determining net cost.

Consistent with the net cost RVC provisions in the Rules of Origin and prior rulings, we determine that the administrative expenses (Administrative Labor, Global Labor, Shelter Fee Costs) which are used to support the AI FJ maquiladora shelter operation and are recorded on American Industries’ books, may be included in the calculation of producer’s total cost for purposes of determining RVC, except for the expenses related to (a) employee saving funds, (b) expatriate assistance and (c) non-production goods and services. Potentially includable costs must be allocated to the products produced for ITT Flojet (and segregated from costs related to products produced for other clients) in accordance with the reasonable allocation provisions of Schedule VII, Rules of Origin. All excluded costs, as specified in Sec. 2(1), must be deducted from total cost in order to arrive at the net cost of the imported ITT Flojet product(s).

Based on the description of the costs at issue, we are of the opinion the following expenses are likely not to qualify as includable costs in the calculation of RVC:

(a) Employee service funds.- Employee service funds are often financed from company profit and thus may be treated as profit sharing, e.i., monies paid out to other persons as dividends. Assuming this to be the case, and depending on the basis of profit, these costs would be treated as excluded costs for purposes of determining RVC. See Sec. 2(6), Rules of Origin.

(b) Expatriate assistance.- Expatriate assistance is generally incurred to support foreign labor relocation (including relocation of employees’ families), is often general in scope and too far removed from product “manufacturing” or “production” to be construed as a part of the net cost of a finished product. Expatriate assistance costs are also sometimes reimbursable and, as such, would not be treated as an actual or real cost to the producer.

(c) Non-production goods and services.- Costs for non-production goods and services are often incurred for sales promotion, marketing or after-sales services. Assuming this to be the case, these expenses would be considered non-includable costs in determining RVC. Otherwise these costs may qualify as includable, provided that all other applicable net cost RVC provisions in the Rules of Origin are met. We note that post-production costs (e.g., costs incurred for customs services related to exportation; post-production human resource services or post-production environmental control) would not be treated as includable in the calculation of RVC. However, pre- and current production costs (e.g., customs or freight forwarding services related to the importation of raw materials and other inputs) could qualify as includable costs, provided that all other applicable net cost RVC provisions in the Rules of Origin are met.

Also, please note that the actual determination as to the inclusion of the costs at issue in determining RVC will be made by the appraising officer at the applicable port of entry and will be based on the documentation submitted. / For NAFTA eligibility purposes, RVC calculations must be made in accordance with Generally Accepted Accounting Principles (“GAAP”) and supported by producer’s internal records, taking into account all relevant costs (including product costs, period costs and other costs). /

HOLDING:

Based on the information provided, the Administrative Labor, Global Labor and Shelter Fee (minus profit) costs recorded on American Industries’ books may be included in the calculation of total cost for purposes of determining RVC, provided that the costs can be reasonably allocated, in accordance with Schedule VII, to the goods at issue. Excluded costs, as specified in Sec. 2(1) in the Rules of Origin, must be deducted from total cost in order to determine the net cost of the specific goods. Costs incurred by the producer in connection with employee saving funds, expatriate assistance, purchase of non-production goods and services, and post-production expenses are likely to be treated as non-includable costs in the calculation of RVC for the reasons stated above.

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 CBP officer handling the transaction.

Sincerely,

Monika R. Brenner, Chief
Valuation and Special Programs Branch

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