OT:RR:CTF:VS H231836 CMR
Kathleen Murphy, Esq.
Drinker Biddle & Reath, LLP
191 North Wacker Drive
Suite 3700
Chicago, IL 60606-1698
RE: Ruling Request on apportionment of assist costs to imported merchandise; 19 U.S.C. § 1401a(b)(C); 19 CFR 152.103(e)
Dear Ms. Murphy:
This is in response to your request of June 29, 2012, on behalf of your client, regarding the prospective apportionment of foreign engineering and design work payments. Your submission proposes a formula for the apportionment of these payments to the value of imported goods.
You and your client’s representatives met with Customs and Border (CBP) personnel from this office to discuss the matter at issue. Supplemental submissions, dated April 12, 2013, and September 12, 2013, and responses to CBP questions have been considered in reaching the decision set forth below.
FACTS:
Your client utilizes engineering and design work services obtained from domestic and foreign firms in the development of its various products. Your client’s products consist of components which it assembles from numerous parts that are produced either in the U.S. or abroad. In addition, your client’s business is a long-cycle business, that is, components are generally sold through long-term contracts, such as “life of program,” i.e., possibly 20+ years. You indicate that while most of the engineering and design work is performed by your client in the United States, a notable amount is undertaken abroad either by your client’s engineers or by foreign engineering and design services firms. In certain cases, the foreign engineering and design services are necessary for the production of the imported merchandise, i.e., parts which will be used to assemble the components your client sells. You acknowledge that such services are assists that should be added to the price actually paid or payable for imported merchandise under transaction value appraisement. You have indicated that in the importations to be covered by this ruling, approximately 99% of which are stated to be subject to no duty, the transactions will be between unrelated parties, at arm’s length, and usually imported on an FCA or Ex-Works basis.
You indicate that it is difficult for your client to apportion the costs of the foreign engineering and design services to individual imported parts because such work is not tracked on the basis of a detailed part or drawing related to a specific part or assembly, but instead is accounted for on an aggregate basis. Additionally, foreign engineering and design work enhancements added to your client’s drawings are not accounted for in drawing records. You state: “Drawings and design plans indicate only the [client’s] engineers who have been involved in approving the project, but not universally the foreign engineering firm involved with specific designs and never to the degree to which a particular engineering firm was involved.”
Accordingly, your client “has developed a foreign engineering design cost formula (the ‘Formula’) that will yield a foreign engineering design cost factor (the ‘Cost Factor’), which [your client] seeks to apply to the import values of many products that it will import.” The cost factor will be applied to imported products on an entry-by-entry basis or under CBP’s Reconciliation Program. You indicate that your client already participates in Reconciliation for valuation issues.
The proposed formula consists of dividing the annual foreign engineering and design costs purchased by the annual cost of goods sold (COGS) less all engineering costs (U.S. and foreign). You state this calculation results in a percentage to be applied to all imported goods which may have benefited from a foreign design or engineering assist. You submit that your client has identified “certain imported product groupings that would not under any circumstances benefit from foreign engineering or design work.” These goods would not have the cost factor applied to them. However, in your April 12, 2013 submission, you state that “. . . the allocation process would increase the declared costs of all imported goods by a cost factor for the foreign engineering and design work, even in instances where the imported goods hardly benefited from the foreign engineering and design work assists.”
The annual COGS amount in the formula includes both imported and domestically produced goods, i.e., the assembled components sold by your client. Imported products are also similarly considered inventory costs, in that they are accumulated into inventory on the balance sheet until incorporated into the cost of production units. Therefore, it is stated that the cost of imported products as well as the cost of the foreign engineering used to design these products is incorporated into the price of the article that is manufactured and sold by your client. It also includes labor and non-labor expenses, as well as some costs, such as facilities, that are allocated to the cost of products. The COGS does not include research and development expenses, certain general and administrative costs, capital asset expenditures, interest or taxes. In addition, the COGS amount and the engineering costs deducted from it are limited to goods produced for commercial purposes. The reason given for using the COGS as a base for allocating the foreign engineering and design costs is that “there is no way to track (or to know with any degree of certainty) whether a foreign-produced drawing has been used in manufacturing that is performed either in the United States or abroad.” Additionally, it is stated that the engineering and design of products “ultimately affects all other costs, whether it is raw material, purchased parts, or the labor of [your client’s] mechanics to perform final assembly.” It is claimed that the design affects all phases of manufacturing and “there is no way of knowing to what extent the drawing was created, revised, or altered by an engineer outside of the U.S.” The COGS amount is based upon contract method accounting. Therefore, “[t]he . . . (“COGS”) represents the Contract Accounting apportionment of all production costs for the year.”
Because it is stated that Contract Accounting is used, and although your client prefers the initial proposed formula, your client has indicated a willingness to use a modified formula in which actual COGS could be used instead of estimated costs. The actual COGS would be calculated by taking the estimated costs reached under the contract accounting method and adding or subtracting, as appropriate, the change in deferred production inventory.
The engineering costs which are to be deducted from the COGS amount includes “all of the direct costs of the engineering organization as included in [your client’s] accounting system[,] . . . including labor costs and direct non-labor costs, such as travel and purchased services.” Further, the engineering and design costs used in the formula are actual calendar year costs. The rationale for deducting all engineering costs from the COGS in the formula is that “while the engineering design work affects all other costs, it does not assist its own development.”
Restated, with all elements based on a calendar year, i.e., annual basis, the proposed formula is:
Actual costs of non-U.S. purchased engineering services costs
COGS – Actual costs of all engineering services
Your client proposes to update the percentage factor on an annual basis after reviewing its foreign engineering costs. The assist will be apportioned over all of your client’s imports into the U.S. for that year (with the exception of those that have been identified as not benefiting from foreign design or engineering work) rather than to a particular part or product line. Your client will report the additional “cost factor” based on the formula either at the time of importation or at Reconciliation. You claim that the proposed apportionment methodology is reasonable and comports with Generally Accepted Accounting Principles (“GAAP”).
You indicate that technical assistance provided by your client’s engineers abroad may, in some instances, be incidental to design and engineering work performed in the United States and thus is exempt from consideration as an assist under 152.102(a)(2). You state this type of technical assistance provided by your client’s employees or agents is outside the scope of this ruling request. You further indicate your client does not have employees domiciled outside of the U.S. performing design work abroad that would be used in the production of the goods imported into the U.S. that are at issue.
With regard to the foreign design and engineering costs, you have indicated that “the turn-around time between when the design modification is completed (or added as a cost) and when the newly designed or modified article is manufactured and imported into the U.S. can vary.” You indicate the turn-around time could be as short as 6 to 9 months or as long as a couple of years, but “. . .a more typical turn-around time for production articles can be approximately 18 months.” Further, “. . ., depending on the nature of the foreign engineering at issue, the cost associated with production in one year, may or may not be directly related to the products manufactured and imported in the following year.” Research and development expenses are not included in the costs for foreign engineering services in the formula as no research and development work attributable to the imported goods is performed by foreign engineering or design firms.
ISSUE:
Whether the proposed methodology for apportioning the foreign engineering and design costs is acceptable under 19 U.S.C. 1401a(b) and 19 C.F.R. §§ 152.102(a) and 152.103.
LAW AND ANALYSIS:
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) codified at 19 U.S.C. § 1401a. The preferred method of appraisement under the TAA is transaction value, defined as "the price actually paid or payable for the merchandise when sold for exportation to the United States," plus certain enumerated additions, including "the value, apportioned as appropriate, of any assist." 19 U.S.C. § 1401a(b)(1)(C).
Section 402(h) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA), codified at 19 U.S.C. § 1401a(h), provides, in relevant part:
(1)(A) The term “assist” means any of the following if supplied directly or indirectly, and free of charge or at reduced cost, by the buyer of imported merchandise for use in connection with the production or the sale for export to the United States of the merchandise:
* * *
Engineering, development, artwork, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise.
No service or work to which subparagraph (A)(iv) applies shall be
treated as an assist for purposes of this section if such service or work –
is performed by an individual who is domiciled within the United
States;
is performed by that individual while he is acting as an employee or agent of the buyer of the imported merchandise; and
is incidental to other engineering, development, artwork, design work, or plans or sketches that are undertaken within the United States.
See also 19 CFR 152.102(a)(1)(iv) and 152.102(a)(2).
With regard to determining the value of an assist described in 19 U.S.C. 1401a(h)(1)(A)(iv), 19 U.S.C. 1401a(h)(1)(C) provides, in relevant part:
(ii) If the production of an assist occurred in the United States and one or more foreign countries, the value of the assist is the value thereof that is added outside the United States.
The statute is silent on apportionment of assists. However, the CBP Regulations, 19 CFR 152.103(e), provide the following with regard to apportionment:
(1) The apportionment of the value of assists to imported merchandise will be made in a reasonable manner appropriate to the circumstances and in accordance with generally accepted accounting principles. The method of apportionment actually accepted by Customs will depend upon the documentation submitted by the importer. If the entire anticipated production using the assist is for exportation to the United States, the total value may be apportioned over (i) the first shipment, if the importer wishes to pay duty on the entire value at once, (ii) the number of units produced up to the time of the first shipment, or (iii) the entire anticipated production. In addition to these three methods, the importer may request some other method of apportionment in accordance with generally accepted accounting principles. If the anticipated production is only partially for exportation to the United States, or if the assist is used in several countries, the method of apportionment will depend upon the documentation submitted by the importer.
With regard to the use of transaction value, 19 U.S.C. § 1401a(b)(1) states that the price actually paid or payable will be increased by an amount attributable to the enumerated additions only to the extent that any such amount is not already included in the price actually paid or payable and is based on sufficient information. The statute states:
If sufficient information is not available, for any reason, with respect to any amount referred to in the preceding sentence, the transaction value of the
imported merchandise concerned shall be treated, for purposes of this section, as one that cannot be determined.
You cite three CBP rulings to support use of the proposed cost factor. In Headquarters Ruling Letter (HQ) H031244, dated April 10, 2009, the method for calculating the assist and allocating it to imports into the United States was fairly straightforward. Because the provider of the assist did not maintain records of design work by garment, the importer proposed taking the total annual salaries paid to employees engaged in design work to all relevant products produced during a calendar year. To that amount was added the courier charges for transporting the artwork and technical specifications packages to the producers. CBP accepted this proposal for calculating the assist and pointed out that only the percentage of that amount attributable to goods imported into the U.S. would be the proper amount. That is, if 50% of the apparel was shipped to the U.S. and 50% shipped elsewhere, then only half of the total assist amount would be attributable to the goods imported into the U.S. The allocation of the assist to the U.S. imported goods was to be based upon the percentage of the total value of the imported goods during the calendar years divided over that value according to the percentage presented by the duty rates of the garments imported that year. CBP accepted this proposal as consistent with 19 CFR § 152.103(c).
In HQ H015975, dated September 13, 2007, the importer could not accurately report the value of the assist per article or shipment, but could determine all assist costs on a monthly basis. CBP determined that the importer could apportion its assist costs “in a monthly declaration such that all assists will be declared on the first entry of the month following the incurrence of such costs provided that such apportionment is in accordance with generally accepted accounting principles.”
You also cite HQ W548164, dated September 20, 2002, as an example of “CBP’s willingness to accept apportionment methods to the extent they are reasonable and in accordance with GAAP. In that ruling, the importer was unable to determine the actual research and development costs that pertained to any single imported research active pharmaceutical ingredient (API). The importer could “establish the actual costs that pertain to all of its API’s produced worldwide in a given fiscal year.” As these research APIs were not imported as the result of a sale or resold in the U.S., CBP accepted the importer’s proposal to use a modified computed value method using a weighted average value for valuing the research APIs, pursuant to the “fallback” method, i.e., 19 U.S.C. § 1401a(f).
In HQ 545031, dated June 30, 1993, an importer proposed using the IRS Alternative Depreciation System to apportion the value of tools, dies and molds for customs purposes as it used that method for tax purposes. Customs held that the proposed apportionment method was not reasonable or appropriate to the circumstances. We stated therein:
. . . The SAA [Statement of Administrative Action], by providing that “once a value has been determined for [an assist], it is necessary to apportion that value to the imported merchandise”, makes it clear that there must be a connection between the apportionment method selected and the imported articles. The SAA offers several suggestions for establishing this link, such as apportioning the full value of the assist over the first entry, or over the number of units produced up to the time of the first shipment, or over the entire anticipated production, in situations where all of the articles produced with the assist will be imported. Tonka’s proposed apportionment method is unreasonable because it is based solely on the estimated useful life of the assist. There is no link between the proposed apportionment method and the imported merchandise.
The problem with the lack of connection between Tonka’s proposed apportionment method and its imported toys becomes apparent when the fact that the class life of the molds usually is longer than the demand for the toys is examined. . . Congress, by requiring the value of assists to be added to the price actually paid or payable, intended the value of assists to be dutiable. . . a proposed apportionment method that routinely allowed a portion of an assist’s value to remain nondutiable would not be acceptable to Customs. . . . The fact that the method is in accordance with GAAP is immaterial.
In this case, you indicate that your client has identified imported products that do not benefit from any foreign engineering or design work and your client will not apply the proposed formula to such goods. Nonetheless, the assist cost factor may be added to some imports that did not benefit from foreign engineering or design work because, as state above, it is difficult to differentiate which parts benefit from foreign and domestic work. Therefore, the value of these imported parts may be inflated. Your client is willing to adjust the COGS to reflect actual costs, as opposed to estimated costs under the contract accounting method. However, the annual design and engineering costs in the formula may not be attributable to the goods imported during the same year that the cost factor is to be applied, but may be attributable to goods
imported in a subsequent year. We find that the reconciliation process will address some of these issues.
As noted, the allocation of foreign engineering and design costs would increase the declared values of all imported goods by the calculated cost factor even where the imported goods did not benefit from the foreign work; however, we agree that this may also understate another inventory item. Given that the goods are primarily duty-free, we do not have the issue of distributing the assist over different dutiable values as in HQ H031244. Further, the entire foreign assists costs will be allocated, unlike in HQ 545031. Accordingly, to the extent that actual COGS will be used via reconciliation and assists costs will be attributed to the extent possible to the goods when they are actually imported (as indicated due to varying turn-around time), we find that the cost factor allocation is reasonable given the circumstances and goods under consideration.
HOLDING:
The proposed method of calculating assists using a cost factor, as described above, is acceptable under 19 U.S.C. § 1401a.
Sincerely,
Monika R. Brenner, Chief
Valuation and Special Programs Branch