HQ H024973
OT:RR:CTF:VS H024973 YAG
Mr. Juan Carlos Moreno
JCM Enterprises
P.O. Box 430332
San Ysidro, CA 92143
RE: NAFTA Eligibility; Regional Value Content; Net Cost Method
Dear Mr. Moreno:
This is in response to your correspondence, dated February 29, 2008 on behalf of JCM Enterprises (the “buyer”), regarding calculation of the regional value content (“RVC”) for audio speakers, to be imported from Mexico. Pursuant to our request for additional information, we also received your email correspondence, dated April 21, 2008, in which you requested an advance ruling concerning the RVC of audio speakers under the North American Free Trade Agreement (“NAFTA”).
FACTS:
The buyer is seeking to import audio speakers produced in Mexico by its wholly-owned subsidiary (the “producer”) through the Port of Otay Mesa, San Diego, California. You have advised us that the goods are classified in tariff items 8518.21 and 8518.22, Harmonized Tariff Schedule of the United States (HTSUS). You also state that the regional value content requirement for the audio speakers is twenty five percent (25%). The buyer subcontracts the direct labor to a company in the United States, which has operations in Mexico. Thus, the buyer pays the unknown U.S. Company for the labor related services in Mexico. This way, you state that the direct labor costs appear on the books of the buyer. Additionally, the buyer provides the producer, on consignment, raw materials, supplies, machinery, and molds to help the producer to manufacture the audio speakers. However, you have advised that the cost of these materials, consigned to the producer, remains on the books of the buyer, rather than on the producer’s books. You seek a ruling with respect to the inclusion of the above-mentioned indirect materials and product costs appearing on the books of the buyer in the total cost for the purpose of determining the RVC of the good under the net cost method and NAFTA eligibility.
ISSUE:
The issue presented is whether the costs described above are included in the calculation of total cost in determining the regional value content of the good under the net cost method.
LAW AND ANALYSIS:
To be eligible for tariff preferences under NAFTA, goods must be “originating goods” within the rules of origin set forth in General Note (“GN”) 12(b), HTSUS, and the NAFTA Rules of Origin Regulations, Appendix to Part 181, Customs Regulations (19 CFR Appendix to Part 181) (the “Rules of Origin”). According to Section 4 of the Rules of Origin, a good will originate if it was “wholly obtained or produced” in accordance with Section 4(1) of the Rules of Origin, or if it satisfies the applicable change in tariff classification, the applicable RVC requirement, or combination thereof under Section 4(2).
According to GN 12(t), HTSUS, in order to be originating a good must undergo a change in classification, satisfy a regional value content requirement, or both. For goods classified under subheadings 8518.10 - 8518.29, HTSUS, GN 12(t) requires either: (1) a tariff shift from any other subheading; or (2) a tariff shift from any subheading within heading 8518, HTSUS, and a certain RVC.
You have indicated that the RVC for the imported merchandise is 25% and that you are using the net cost method, not the transaction value method to calculate the applicable RVC. Please note that we do not have enough information to rule on the applicability of the transaction value method to calculate RVC. Pursuant to Section 6(3) of the Rules of Origin, the RVC of a good is equal to the net cost of the good minus the value of non-originating materials (“VNM”), divided by the net cost. The net cost of the good is determined according to Sections 2(6) and 6(11) of the Rules of Origin, pursuant to which there are several options for determining the net cost of a good, all of which involve a calculation of the producer’s total cost. Section 2(6) describes the calculation of the producer’s cost and states as follows:
For purposes of sections 5(9), 6(11) and 7(6) and sections 10(1)(a) (i) and (ii),
(a) total cost consists of all product costs, period costs and other costs that are recorded, except as otherwise provided in paragraphs (b) (i) and (ii), on the books of the producer without regard to the location of the persons to whom payments with respect to those costs are made;
(b) in calculating total cost,
(i) the value of materials, other than intermediate materials, indirect materials and packing materials and containers, shall be the value determined in accordance with section 7(1);
(ii) the value of intermediate materials used in the production of the good or material with respect to which total cost is being calculated shall be calculated in accordance with section 7(6);
(iii) the value of indirect materials and the value of packing materials and containers shall be the costs that are recorded on the books of the producer for those materials; and,
(iv) product costs, period costs and other costs, other than costs referred to in subparagraphs (i) and (ii), shall be the costs thereof that are recorded on the books of the producer for those costs;
You have asked whether the cost, recorded on the books of the buyer, of certain raw materials and supplies (the “materials”) can be included in total cost. For NAFTA purposes, the term “material” is defined as “a good that is used in the production of another good, and includes a part or ingredient.” Rules of Origin, Section 2(1). Assuming that raw materials and supplies will be used in the production of the good at issue, these materials are materials for NAFTA purposes. Total cost is determined on the basis of the expenses recorded in the books of the producer, except that, in the case of materials, pursuant to Section 2(6)(b)(1), total cost is determined in accordance with section 7(1) of the Rules of Origin. Under section 7(1), except as otherwise provided, the value of a material imported by the producer of a good into the territory of the NAFTA country in which the good is produced, is its customs value. In the instant case, the consigned materials are imported by the producer into Mexico. Accordingly, for purposes of the net cost determination, the total cost of the materials consigned to the producer should be based on their customs value.
Furthermore, please note that the production machinery, molds, and tools, recorded on the books of the buyer and consigned by the buyer to the producer in Mexico are considered “indirect materials.” The term “indirect material” is defined in relevant part for NAFTA purposes as “a good used in the production, testing or inspection of a good but not physically incorporated into the good, or a good used in the maintenance of buildings or the operation of equipment associated with the production of a good.” Rules of Origin, Section 2(1). Section 2(6)(b)(iii) provides that the value of indirect materials shall be the costs that are recorded on the books of the producer for those materials. Furthermore, Section 7(11)(b) of the Rules of Origin pertaining to indirect materials states that “if the good is subject to a regional value-content requirement, for purposes calculating the net cost under the net cost method, the value of the indirect material shall be the costs of that material that are recorded on the books of the producer of the good.” Thus, the indirect materials, supplied by the buyer to a Mexican producer and appearing on the buyer’s books, cannot be included in calculation of the total costs for purposes of determining RVC. In Headquarters Ruling Letter (“HRL”) 545635, CBP ruled that certain expenses, which were recorded on the books of the U.S. importer, could not be included in the calculation of the total costs for purposes of determining RVC. The producer in that case was also a wholly-owned Mexican subsidiary of the importer. The expenses which were carried on the importer’s books included materials consigned to the producer, such as general purpose machinery, equipment, tools, dies, research and development, engineering, salaries of U.S. personnel visiting or working in the producer’s plant, and material acquisition costs. CBP determined 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. See also HRL 547881, dated August 27, 2001.
Additionally, you state that the direct labor costs are paid by the buyer to a U.S. company, and appear on the books of the buyer. An unknown company in Mexico is the actual producer of audio speakers, not the buyer. You assert that the direct labor costs should be part of the RVC calculation because even though the workers are hired through a U.S. Company, they are the actual assemblers directly involved in the production of the goods. Direct labor costs are defined as “costs, including fringe benefits, that are associated with employees who are directly involved in the production of a good.” Rules of Origin, Section 2(1). Also, as you correctly state, under NAFTA, direct labor costs are part of the product costs associated with the production of a good. Rules of Origin, Section 2(1). Further, direct labor costs fall under 19 CFR 181, App. Section 2(6)(b)(iv). Section 2(6)(b)(iv) states that “product costs, period costs, and other costs, other than costs referred to in subparagraphs (i) and (ii), shall be the costs thereof that are recorded on the books of the producer for those costs.” Therefore, regardless of the employees’ functions, location, and nationality of prospective employees, pursuant to the Rules of Origin, only the costs recorded on the producer’s books may be included in the calculation of total cost for purposes of determining RVC. Our determination is again supported by the HRL 545635, dated November 29, 1994, wherein we determined that in accordance with Section 6(12) of the Rules of Origin, the cost of research and development, engineering and the salaries of U.S. personnel, recorded on the buyer’s books, but attributable to the production of the good were not included in the calculation of total cost, because items in question were not on the producer’s books.
HOLDING:
In calculating the total cost of the good for purposes of determining its net cost, the costs, not on the producer’s books, of the indirect materials, direct labor costs, and other items described above, are not included in total cost in determining the regional value content of the good under the net cost method.
This holding applies only to the specific factual situation and merchandise identified in this ruling request. This position is clearly set forth in Section 181.100(a)(2), CBP Regulations, which states that a NAFTA ruling letter is issued on the assumption that all the information furnished in connection with the ruling request and incorporated therein, directly, by reference, or by implication, is accurate and complete in every respect. Should it subsequently be determined that the information furnished is not complete and/or does not comply with 19 CFR § 181.100(a)(2), this ruling will be subject to modification or revocation. In addition, any change in the facts furnished in connection with this ruling may affect the outcome of the regional value content determination. In such a case, it is recommended that a new ruling be submitted in accordance with 19 CFR § 181.93.
Sincerely,
Monika R. Brenner, Chief
Valuation & Special Programs Branch