CLA-2 OT:RR:CTF:VS H192144 KSG
Field Director
Office of Regulatory Audit, Miami
Office of International Trade
U.S. Customs and Border Protection
6601 NW 25th Street
Miami, Florida 33122
Re: Request for Internal Advice; GSP; substantial transformation; lenses
Dear Field Director:
This is in reference to your memorandum dated October 31, 2011, requesting Internal Advice concerning the eligibility of certain imported coated plastic optical photochromic lenses for preferential tariff treatment under the Generalized System of Preferences (“GSP”). At the request of counsel, two conferences were held on this matter at Headquarters on October 11, 2012, and on January 9, 2013. Additional submissions, dated October 11, 2012, November 9, 2012, and February 19, 2013, were considered.
FACTS:
The case involves lenses that are coated with a patented photochromic dye, which causes the lens to darken when exposed to ultraviolet light. The lenses are imported by Transitions Optical, Inc., located in Florida. The scope of the audit was for entries made from January 1, 2009, through December 31, 2009. CBP examined 10 entries made in that period.
Plastic optical lenses, specifically 1.5mm substrates, were manufactured in the Philippines or Thailand by Essilor Optodev Inc., Essilor Manufacturing (Thailand) or other unrelated and related companies. Essilor Optodev Inc. and Essilor Manufacturing are related to Transitions. The audit report states that substrates were purchased from other countries as well but were separately stored and are not at issue.
Chemicals used to produce the substrates were manufactured in the U.S. and Japan. To produce the substrates in Thailand or the Philippines, foreign-origin monomers, initiator and additives were chilled and blended, poured into glass molds, thermally cured in a water bath or air oven, removed from the molds, cured again, and inspected. The substrates were then sold to Transitions. In Thailand or the Philippines, the clear substrates were coated with photochromic dye produced in the U.S. at manufacturing facilities owned and operated by Transitions Optical in the Philippines or in Thailand.
The process performed in the Philippines is called imbibition and is a patented process covered under U.S. Patent Number 5,185,390. Photographs of this process were presented. The imbibing process involves incorporating the photochromic substance into the lens via a thermal diffusion process.
The process performed in Thailand is called trans-bonding, which is also a patented process covered by U.S. Patent Number 7,410,691 B2. It involves a combination of surface, thermal and radiation treatments to clear lenses, and coatings that are applied to the lenses. Although the trans-bonding process applies the photochromic dyes in a different manner, when exposed to sunlight, the lenses change color and then revert to their clear form. As a result of these patented processes, when the finished lens is exposed to the ultraviolet radiation of sunlight, it changes color. This provides protection to the eyes. The coated lenses were then packed and shipped to the U.S.
The Office of Regulatory Audit conducted a Pre-Assessment Survey Report dated March 23, 2011, which concluded that Transitions did not establish the 35 percent value-content requirement was satisfied for these goods. Counsel states that it has always assumed that the only remaining issue was what type of documentation was necessary to support the input cost from the lens supplier. Counsel claims that the invoice price of the lens supplier should be satisfactory to support the cost or value. Your office requested that the importer supply information on the producing parties’ costs, such as materials, labor, overhead, and profit.
ISSUE:
Whether the imported coated plastic optical lenses are eligible for preferential tariff treatment under the GSP?
ISSUE AND ANALYSIS:
Title V of the Trade Act of 1974, as amended (19 U.S.C.A. 2461-65), authorizes the President to establish a Generalized System of Preferences (“GSP”) to provide duty-free treatment for eligible articles from beneficiary developing countries (“BDCs”). Articles produced in a BDC may qualify for duty-free treatment under the GSP if the goods are imported directly into the customs territory of the U.S. from the BDC and the sum or value of materials produced in the BDC plus the direct costs of the processing operations performed in the BDC is equivalent to at least 35 percent of the appraised value of the article at the time of entry into the U.S. See 19 U.S.C. 2463(a)(2) and (3).
ASEAN (which includes Thailand and the Philippines) has been designated as an association of countries treated as one BDC country for purposes of the GSP and may be afforded preferential treatment under the Harmonized Tariff Schedule of the United States (“HTSUS”). See General Note (“GN”) 4(a), HTSUS. A good is considered to be a “product of” a BDC if it is wholly the growth, product or manufacture of the BDC, or if made of materials imported into the BDC, those materials are substantially transformed in the BDC into a new and different article of commerce. See 19 CFR 10.176(a). A substantial transformation occurs “when an article emerges from a manufacturing process with a name, character, or use which differs from those of the original material subjected to the process.” Texas Instruments Inc. v. United States, 681 F.2d 778 (Fed. Cir.1982).
To be eligible for duty-free treatment under the GSP, merchandise must also satisfy the 35 percent value-content requirement. If an article consists of materials that are imported into a BDC, as in the instant case, the cost or value of these materials may be counted toward the 35 percent value-content requirement only if they undergo a double substantial transformation in the BDC. The purpose of the double substantial transformation rule is to ensure that a significant portion of the value of the good results from processing performed in the BDC and/or materials that originate in the BDC. The regulation set forth at 19 CFR 10.177(a) governing the cost or value of materials produced in the BDC, states that the words “produced in the beneficiary developing country” refers to the constituent materials of which the eligible article is composed which are either: (1) Wholly the growth, product, or manufacture of the beneficiary developing country; or (2) Substantially transformed in the beneficiary developing country into a new and different article of commerce.
The chemicals used to make the lenses are produced in either the U.S. or Japan. Since the chemicals are not produced in the BDC, they would only count toward the 35 percent value-content requirement if they undergo a double substantial transformation. We agree that the production of the substrates in Thailand or the Philippines from the chemicals would constitute a substantial transformation, creating a new article with a new name, character and use. See Headquarters Ruling Letter (HQ) 555923, dated June 17, 1991. Therefore, the substrate produced in the BDC would satisfy the “product of” requirement.
Counsel claims that the imbibing or trans-bonding process, as the case may be, is a second substantial transformation. All the processing is performed in one GSP country (or within the association) and counsel argues that the claimed second substantial transformation is more than a simple pass-through operation which involves a significant investment in capital equipment in the GSP country, employment of skilled technical employees, and a patented process. Counsel also contends that since there is a second substantial transformation, the cost of the intermediate material, the substrate, should be counted toward the 35 percent value-content requirement for the GSP.
In HQ H088695, dated March 12, 2010, CBP ruled that grinding non-BDC origin substrates, coating, and inserting them into eyeglass frames did not constitute a substantial transformation into a product of the BDC. The requestor of the decision did not describe the coating process in detail. In HQ H070864, dated October 9, 2009, CBP considered whether lenses were eligible for a partial duty exemption under subheading 9802.00.50, HTSUS. CBP ruled that polycarbonate prescription lenses sent to Thailand for the application of a photochromatic dye and scratch resistant coating were finished articles when sent to Thailand, and that the process did not destroy the identity of the exported lenses and constituted an alteration under subheading 9802.00.50, HTSUS, as a result of the processing in Thailand. Counsel argues that a second substantial transformation for the purposes of the GSP “can be something less than a traditional substantial transformation”, and that, therefore, the 9802.00.50 determination does in HQ 070864 not conflict with a finding of a second substantial transformation for purposes of the GSP in this instance.
In previous GSP cases, we have stated that where all of the processing is accomplished in one GSP country, the likelihood that the processing constitutes little more than a “pass-through” operation is greatly diminished. Consequently, if the entire processing operation performed in the single BDC is significant, and the intermediate and final articles are distinct articles of commerce, then the double substantial transformation requirement will be satisfied. Such is the case even though the processing required to convert the intermediate article into the final article is relatively simple and standing alone, probably would not be considered a substantial transformation. See HRL 561245, dated June 24, 1999. In Torrington Co. v. United States, 764 F.2d 1563 at 1571 (CAFC 1985), the court stated that “…we look - keeping in mind the GSP’s fundamental purpose of fostering industrialization in BDCs – to the actual manufacturing process by which the intermediate article becomes the final product.” Accordingly, the court held that the production of needles from swages was a significant manufacturing process, and not a mere “pass-through” operation.
In this case, based on the particular facts of this case, which involve a complex patented process, a large capital investment for equipment in the BDC, employment of skilled technical personnel, and consideration that the standard for the second substantial transformation for purposes of the GSP differs from what constitutes a first substantial transformation, we find that the substrates undergo a second substantial transformation in the BDC country by the photochromatic dye operations, whether by the imbibition or trans-bonding process, and that these operations are more than pass-through operations.
The list of costs or values included in the 35 value-content calculation are set forth at 19 CFR 10.177(c) and 19 CFR 10.178(a). The material costs are provided for in 19 CFR 10.177(c) and include the following:
The manufacturer’s actual cost for the materials;
When not included in the manufacturer’s actual cost for the materials, the freight, insurance, packing and all other costs incurred in transporting the materials to the manufacturer’s plant;
The actual cost of waste or spoilage (material list), less the value of recoverable scrap; and
Taxes and/or duties imposed on the materials by the beneficiary developing country or an association of countries treated as one country, provided they are not remitted upon exportation.
The regulations provide for a different calculation and determination when the material is provided to the manufacturer without charge, or at less than fair market value, and if the pertinent information is not available, the appraising officer may ascertain or estimate the value thereof using all reasonable ways and means at his disposal. 19 CFR 10.177(c)(2).
The direct costs of processing to be included are provided for at 19 CFR 10.178(a) and include the following:
(i) All actual labor costs involved in the growth, production, manufacture, or assembly of the specific merchandise, including fringe benefits, on-the-job training, and the cost of engineering, supervisory, quality control, and similar personnel;
(ii) Dies, molds, tooling and depreciation on machinery and equipment which are allocable to the specific merchandise;
(iii) Research, development, design, engineering, and blueprint costs insofar as they are allocable to the specific merchandise; and
(iv) Costs of inspecting and testing the specific merchandise.
CBP has examined what material costs may be included in calculating the 35 percent. For example, in HQ 055719, dated October 30, 1979, sunglasses were manufactured in Haiti from imported materials. Among those materials, flat plastic pieces (lens blanks) were dyed, pressed into convex shapes, cut to the size of the frame, and inserted into the frame. It was held that only the lenses, produced from the imported plastic lens blanks, were constituent materials produced in Haiti. In HQ 553059, dated September 5, 1984, chairs were made in Barbados and the 35 percent value-content was discussed. Brazilian mahogany lumber was imported into Barbados and kiln dried. The kiln dried lumber was then sold to a Barbados chair manufacturer for $62.25 per chair, which took into account the costs of the board per foot, kilning, and labor. The kiln dried lumber was then machined into shape, after which it was assembled into chairs. It was determined that kiln drying the lumber was a substantial transformation, and that the cost or value of the dried lumber, represented by the manufacturer’s actual costs, or in the particular case, $62.25 per chair (less any recoverable scrap) could be counted toward the 35 percent. See also HQ 555195, dated July 13, 1989 (the cost or value of constituent materials (aluminum slats) made from non-BDC aluminum flat coil stock and used in the assembly of mini-blinds may be included for purposes of satisfying the 35 percent value-content requirement); HQ 555515, dated April 9, 1990 (the production of magnetics and PCB's involved substantial operations (cutting, shaping, winding, tinning, soldering and quality control testing) and transformed them into articles with distinct new commercial identities, thereby allowing the cost or value of these constituent materials (the magnetics and PCBA's) to be included for purposes of satisfying the 35 percent value-content requirement under the GSP after they underwent a second substantial transformation with other parts (fan, power switch, voltage select switch, receptacles, connector cables, and metal chassis) to create the final article -- the Model AA14220-115 power supply).
As provided in 19 CFR 10.177(c) and 10.178, the material costs and the direct costs of processing performed in the Philippines (or Thailand) may be counted towards the 35 percent value-content requirement. Counsel claims that based on the regulations, the price paid by the manufacturer, that is, the invoice price for the local inputs and records of payment of those invoices, plus the cost to transport the materials to the manufacturer’s plant, is the cost to include in the 35 percent calculation. Therefore, counsel claims that the invoice price of the substrates incurred by Transitions Optical in the Philippines (or Thailand), supported by evidence of payment of the invoice price is all that is required to be presented, and that there is no need to provide documentary evidence of what makes up the invoice price. Counsel states the costs incurred by Transitions Optical to produce the lenses were provided. The Office of Regulatory Audit required documentation on the costs used by the BDC producers of the substrates, and found that Transitions did not have controls in place to obtain documentation from its lens suppliers in Thailand and the Philippines to verify the costs.
CBP considered substantiating documentation in HQ 555189, dated June 12, 1989, where CBP found that umbrella tops were substantially transformed constituent materials for purposes of the GSP when made from continuous length nylon fabric, and that their cost or value could be counted toward the 35 percent value-content requirement when made into umbrellas in a GSP country. Further, at issue was the [district] director’s question and belief whether the cost data supplied by the importer was sufficient to support the conclusion that the 35 percent value-content requirement was met. In HQ 555189, CBP cited 19 CFR 10.172, noting that a claim for exemption from duty under the GSP may be denied by the [district] director if he is not satisfied that the country of origin criteria and other regulatory requirements have been met. Accordingly, it was noted that the [district] directory could deny the importer's claim for exemption on that basis, or require presentation of additional evidence verifying the importer's cost data.
In this context, we note that 19 CFR 10.173(c), provides that:
Any evidence of country of origin submitted under this section shall be subject to such verification as the port director deems necessary. In the event that the port director is prevented from obtaining the necessary verification, the port director may treat the entry as dutiable.
In this case, consistent with the rulings cited above, we find that the constituent materials (substrates) may be counted toward the 35 percent value-content requirement. In accordance with 19 CFR 10.173(c), the Port may verify that the supporting documentation substantiates the costs figures, including the actual cost of the materials and all actual labor costs. See HQ 562302, dated September 27, 2002; and HQ 556224, dated September 8, 1992.
The Office of Regulatory Audit requested that Transitions provide supporting records, such as bills of materials, production records, affidavits for originating materials, invoices for all materials, cost breakdowns of the direct costs of processing of the producer’s finished lenses, and a demonstration of the calculation of the 35 percent value content requirement. The purpose of the request was to verify that the lenses purchased by Transitions’ facilities in the Philippines and Thailand are, indeed, manufactured in the BDC, and that the related party value of the materials was acceptable. Counsel claims that the actual costs of the clear substrate lens sold to Transitions Optical Philippines by substrate manufacturers in the Philippines and as established by the commercial invoice issued by the Philippine substrate manufacturer is sufficient to establish the costs of the material as required by 19 CFR 10.173.
Counsel cites HQ H115766, dated December 23, 2011, for support that CBP has accepted an invoice as proof of the costs of materials. However, in that case, the manufacturer of the constituent material (a decal), was not related to the final manufacturer and user of the decal. See also HQ H041936, dated January 27, 2010, (non-related party invoices were accepted by CBP to substantiate material costs). Counsel also states that as a matter of equity, it would be unfair to reject an invoice value from a horizontal transaction between related parties.
Per 19 CFR 10.177(c)(2), CBP may verify the cost or value of a material and determine if it may have been provided at less than fair market value. Accordingly, it is our opinion that CBP has the authority to request further substantiating information that an invoice price between related parties for a material that was used in production of the final article was sold at fair market value. Counsel states that it has provided a record payment from Transitions to the related substrate manufacturers to show that payments were made. Further, counsel has now submitted information on the production of the substrate from the related party; amongst the documents submitted is a document representing the purchase record from the substrate manufacturer of the monomer used, an invoice from the monomer supplier, production of the substrates and employees, and invoices and payment for the substrates. It is our opinion that based on the information submitted, there is no evidence to suggest that the substrates sold to Transitions Optical in the Philippines or Thailand were sold at less than fair market value; however, the appraising officer’s may utilize the other information and methods set forth in 19 CFR 10.177(c)(2), if there is a question as to the fair market value.
HOLDING:
Coating the substrates with a photochromic dye constitutes a second substantial transformation. Accordingly, the cost of the non-BDC-origin chemicals may be counted toward the 35% value-content requirement.
This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, the Office of Regulations and Rulings will make the decision available to CBP personnel, and to the public on the CBP Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.
Sincerely,
Monika R. Brenner, Chief
Valuation & Special Programs Branch