VAL CO:R:C:V 545320 IOR
District Director
Chicago, Illinois
RE: Internal advice; dutiability of research and engineering charges
Dear Sir:
We are in receipt of your internal advice request dated April 15, 1993, regarding the dutiability of research, development and engineering ("R&D") fees paid by xxxxxxx xxxxxx xxxxxxxxxxx (hereinafter referred to as the "importer") to its subsidiary xxxxxxxxxxxxxxxxxx xxxxxxxx xxxx (hereinafter referred to as "HEC"), located in the United Kingdom. Our file includes the importer's submission requesting internal advice dated January 28, 1993, the importer's supplemental submission dated June 3, 1994 and an NIS report dated May 10, 1993. Certain information for which the importer has requested confidentiality is not contained in this decision. This response follows a May 3, 1994 meeting between counsel and a representative on behalf of the importer, and members of my staff in the Value Branch. We regret the delay in responding.
FACTS:
At issue is the appraisement of various imported prototype hardware items produced by HEC. The declared value of the prototypes was based upon the cost of labor, materials and overhead used in the production of the prototypes. The amount of R&D payments made to HEC by the importer were not included in the value of the prototypes and were not declared to Customs at the time of entry. The imported merchandise was entered from July, 1989 through June, 1990. The entries were liquidated before the R&D payments were discovered. The R&D payments were discovered by the importer during an in-house audit and reported to Customs.
According to the submission made on its behalf, the importer is a large U.S. manufacturer of diesel engines. In 1987 the importer began an engine design project (this is hereinafter referred to as the "Project"). The importer contracted with HEC for R&D services for the Project. HEC was reimbursed, on a monthly basis, by the importer for the full cost of the R&D conducted in the U.K.
According to the importer's submission, during the early stages of the Project, the importer had discussed, but not decided, to manufacture the project engine if development was successful in a U.S. plant. As part of the research and design of the project engine, HEC produced numerous prototype hardware items for testing to determine whether the theoretical designs and computer simulations of the various component research projects had practical effect and could be used for further considerations. Several of the component research projects were never incorporated into a prototype. Of the 60 prototypes which were produced by HEC, only 20 were imported into the U.S. According to the importer's supplemental submission, of the total cost of the Project, 15.5% was spent for hardware, and approximately 2.4% was spent on the imported prototypes. The remaining amount was for engineering fees. The importer states in the supplemental submission that it would be an extreme administrative burden to segregate the costs spent for research related to any given prototype.
In its submissions, the importer states that the purpose of the imported prototypes was for HEC to report to the importer as to the progress of the research, and for the importer to test the prototypes to review the research project. The importer states that the intended end product of the Project was a set of engineering drawings and specifications that could be used to produce the project engine. The importer claims that it paid HEC for services and not merchandise, and emphasizes that the imported prototypes are not products and were never intended to enter into the U.S. stream of commerce, and never did enter into the U.S. stream of commerce. In its supplemental submission, the importer states that due to cost inefficiency, the Project was abandoned and no final product was ever produced.
It is the importer's position that the fees paid by the importer to HEC for R&D are not dutiable as part of the appraised value of the imported prototypes, and in the alternative, if the fees are part of the appraised value, the portion of the expense paid for R&D which was conceptual in nature and not necessary for the manufacture of the final product are not dutiable. On different grounds, the importer claims that 1) the prototypes are reports on the progress and results of the R&D performed by HEC, and are therefore exempt from duties under Harmonized Tariff Schedule of the United States (HTSUS) General Headnote 4© and 2) the prototypes never reached and were never intended to reach the stream of commerce in the U.S. and therefore they are not dutiable.
ISSUE:
Whether the payments made by the importer to HEC for R&D should have been included in the appraised value of the imported merchandise.
LAW AND ANALYSIS:
The preferred method of appraisement is transaction value which is defined by §402(b)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA, 19 U.S.C. 1401a(b)) as "the price actually paid or payable for the merchandise when sold for exportation to the United States..." plus certain additions specified in §402(b)(1) (A) through (E). The term "price actually paid or payable" is defined in TAA §402(b)(4)(A) as:
...the total payment (whether direct or indirect...) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller.
The parties are related, therefore pursuant to §402(b)(2)(B) of the TAA, transaction value is acceptable only if an examination of the circumstances of the sale indicates that the relationship between the buyer and seller did not influence the price actually paid or payable or if the transaction value of the imported merchandise closely approximates the transaction value of identical or similar merchandise in sales to unrelated buyers in the U.S. or the deductive or computed value for identical or similar merchandise. We do not have enough information to determine whether transaction value is an acceptable basis of appraisement in this case, however, for the purpose of this response, we are assuming that transaction value is the appropriate basis of appraisement.
It has been the longstanding position of the Customs Service that all monies paid to the foreign seller, or a party related to the seller, are part of the price actually paid or payable for the imported merchandise under transaction value. See Headquarters Ruling Letter (HRL) 542169 (TAA#6) dated September 18, 1980. Our position has been affirmed by the Court in Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed Cir. 1990); HRL 544640 dated April 26, 1991. It is also well-settled that amounts paid to the seller by the importer are included in the price actually paid or payable whether the payments are for R&D, mold or tool expenses. See e.g. C.S.D. 83-3; HRL 543324 dated August 8, 1984; HRL 543376 dated November 13, 1984; HRL 543983 dated December 2, 1987.
The importer takes the position that because the prototypes never resulted in a commercial product and the importer did not produce anything beyond the prototype stage, the R&D could not have been necessary for the production of an imported product. There is no legal support for the importer's position that the imported prototypes cannot be considered dutiable imported "merchandise" for the production of which the R&D was necessary.
In support of its argument that the R&D payments do not attach to the imported prototypes, the importer cites HRL 545278 dated April 7, 1994, in which Customs ruled that the R&D cost paid for the development of prototype engines "is a cost attributable to the production engines and should therefore, be included in transaction value as part of the price actually paid or payable for the subsequently imported production engines." Although it may not be apparent from the language of HRL 545278, the R&D costs paid by the importer were included in the appraised value of the imported prototype engines. Therefore, HRL 545278 supports a finding that R&D costs incurred in the production of prototypes from which no subsequent merchandise is ever manufactured, can be included in the appraised value of the imported prototypes.
In further support of its position that the value of the R&D does not attach to a prototype and is not realized until a final product is manufactured, the importer refers to HRL 544642 dated June 24, 1991, which is a reconsideration of HRL 544516, dated January 9, 1991. The importer infers that if a prototype never results in the importation of a final product, no portion of the payments would be dutiable. However, in HRL 544642, we ruled that the importer's cost of the prototype was the value of an assist to the manufacturer of the final product, as the prototype was returned to the foreign manufacturer free of charge (after having been brought into the U.S. under carnet) and that the cost of development was part of the price actually paid or payable for the subsequently imported merchandise. In HRL 544642 we did not reach the issue of whether the development cost was included in the price actually paid or payable for the prototype since the prototype had never been entered into the U.S. for consumption. Here, the subject prototypes were entered into the U.S. for consumption.
As an analogy to the subject facts, the importer cites HRL 544516 dated January 9, 1991, HRL 543983 dated December 2, 1987 and HRL 542812 dated July 19, 1982 in support of the position that payments made by the buyer for R&D work done before a production design is determined are not assists. The status of a production design is not material in the cited rulings, which state that the payments in question are not assists, but are part of the price actually paid or payable for the imported merchandise.
Under the circumstances presented, we have no authority to exclude R&D payments from the appraised value of the imported prototypes. The appraisement statute and prior rulings do not distinguish between the dutiability of R&D for imported prototypes and R&D for other imported merchandise. We find that the payments for R&D made to HEC by the importer, are part of the price actually paid or payable for the imported prototypes. Further, the fact that the transaction did not involve the sale of a commercial product, does not preclude appraisement based on transaction value.
In support of its position that payments for R&D which is conceptual in nature are not included in the price actually paid or payable, the importer refers to HRL 542609 dated January 8, 1982 and HRL 540753 dated July 19, 1977. However neither of these rulings apply the TAA. In HRL 543376 dated November 13, 1984, decided under the TAA, we did not address the "conceptual in nature" issue, however we did find that a charge for development and design which was "essential to the production" of the imported merchandise, was included in the price actually paid or payable for the imported merchandise.
In Chrysler Corporation v. United States, No. 93-186, slip op. (Ct. Int'l Trade September 22, 1993), the Court found that tooling costs were properly allocated over the number of engines anticipated to be produced as opposed to the number of engines imported. Similarly, in this case, the R&D costs could be allocated over the 60 prototypes produced, as opposed to the twenty that were imported. In Chrysler, the Court found that the importer provided uncontradicted evidence that the tooling costs were intended to affect all of the engines anticipated to be produced. In this case the importer states that only a small portion of the R&D cost was necessary for the development of the imported prototypes, however, the importer nevertheless states that it cannot segregate the costs which were incurred with respect to the imported prototypes without suffering an extreme administrative burden. Without evidentiary support for apportionment, we cannot determine what portion of the total R&D payment was for the imported prototypes. Unless the importer provides Customs with documentation in support of allocating the R&D costs over the 60 prototypes, we must necessarily find the total payment is part of the price actually paid or payable for the imported prototypes.
The importer takes the position that the prototypes are not dutiable because they are not imported products. In support of this position the importer asserts that the prototypes are exempt from duties under HTSUS General Headnote 4(c), on the grounds that the prototypes are "progress reports." HTSUS 4© is specifically limited to "records, diagrams and other data with regard to any business, engineering or exploration operation whether on paper, cards, photographs, blueprints, tapes or other media." The imported hardware prototypes do not fall within the description of any of the foregoing. It is apparent that the imported merchandise does not qualify under HTSUS General Headnote 4(c). The merchandise was entered under HTSUS Chapter 84 which covers "machinery and mechanical appliances; electrical equipment; parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, and parts and accessories of such articles."
In its supplemental submission, to further support the position that the prototypes should not be subject to duty, the importer analogizes the imported prototypes to merchandise entered under temporary importation bond (TIB) under HTSUS Chapter 9813.00.30, and samples entered under HTSUS Chapter 9811.00.60. We find this argument to be without merit for appraisement purposes. What is significant is how the merchandise was entered, not how it could have been entered.
HOLDING:
The payments made by the importer to HEC for R&D should have been included in the price actually paid or payable for the imported prototypes.
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, Freedom of Information Act and other public access channels.
Sincerely,
John Durant, Director
Commercial Rulings Division