FOR-2-03-CO:R:C:E 223330 PH

Mr. Loren D. Roth
Senior Vice President-Operations
The Joseph & Feiss Company
Post Office Box 5968
Cleveland, Ohio 44101

RE: Processing of Fabric in Foreign Trade Zone (FTZ); Allowance for Shrinkage, Defective Fabric, or Scrap Resulting from Cutting Process; 19 U.S.C. 81c(a)

Dear Mr. Roth:

In your letter of July 15, 1991, you request a ruling on the dutiability of fabric processed in a foreign trade subzone. You enclose a number of documents relating to your request. We met with you on September 24, 1991, and we have communicated with officials of the Foreign-Trade Zones Board (FTZ Board) about this matter. Our ruling follows.

In addition to ruling on your request, we are commenting on an alternative to your proposed operation which we understand the FTZ Board is considering. Representatives of your company, representatives of the Office of Textiles and Apparel in the Department of Commerce ("OTEXA"), staff members of the honorable Edward F. Feighan, Member of Congress, and representatives from this office met about this matter on January 27, 1992. At this meeting, we stated that we would wait for your comments on this matter for several days before issuing a ruling in response to your July 15, 1991, ruling request. Since we have not heard from you about this matter since the January 27 meeting, we are now issuing the ruling. If you have any further questions about this matter, please feel free to call on me or Mr. William G. Rosoff, Chief of the Entry Rulings Branch (202-566-5856), which is the Branch responsible for the subject of this ruling.

FACTS:

You state that your company has formally applied to the FTZ Board to be granted foreign trade subzone status. You enclose a letter in which the OTEXA recommended to the FTZ Board that such status be granted under certain conditions. The first of these conditions is that duty for the fabric would be assessed at the fabric rate and that defects may be dutiable at the appropriate lower rate of duty. Second, quota and non-quota goods must be differentiated for entry, quota goods must be accompanied by a visa, after defects are identified the fabric may be entered into Customs territory and charged to quota, and duty must be paid on defects for both non-quota and quota goods. Your company would then be free to simultaneously cut the quota, non-quota, and domestic goods outside the subzone or in a deactivated area with the subzone. Third, your company would have to obtain the approval of Customs for assessing a lower rate of duty on the defects which are not physically separated from the fabric before it is removed from the subzone.

You include a description of the procedures for handling the fabric and a flow chart demonstrating the procedures. According to this description, after filing of appropriate documentation and the initial inspection of the fabric, each bolt or piece of fabric is uniquely identified and examined and measured. Damages or defects are marked with stringers in the selvage (outside edge) of the fabric. If more than 18 damages or defects are found, the fabric is rejected and scheduled for return to the foreign manufacturer, never entering Customs territory. Fabric which is accepted is sent to a storage area.

Before being sent to the storage area, certain fabrics go through the process of sponging and stabilizing. This process results in shrinkage, so that the fabric is re-measured and the new measurements are recorded.

In the storage area the fabric is stored in bins and is controlled by a computer record-keeping process. All of the information required by 19 CFR 146.23 is contained in these records.

Pieces of fabric remain in the storage area until they are needed for production. When cutting documents are created, notification is sent to the storage area to pull the fabric to be used for the particular cutting. When the fabric is pulled, personnel in the storage area note the quantity of defects in the fabric and then add additional fabric to cover loss due to the defects. Based on experience, your company allows 1 additional increment of fabric for 1 to 6 defects, 2 additional increments for 7 to 12 defects, and 3 additional increments for 13 to 18 defects. An additional yard of fabric is allowed for each "bar" defect (i.e., damage running the width of the fabric).

Under your proposal, after the necessary yardage has been pulled in the storage area, the appropriate duty would be assessed. It is proposed that this duty would be calculated on the total quantity of yardage pulled, less the defective yardage. After calculation of the duty due, the yardage would be removed from the subzone and, only then, would the actual cutting take place. After cutting, all damaged pieces would be re-cut and the damaged pieces would be destroyed.

Some of the fabric which is sent to the storage area would be sold to other manufacturers rather than being used by your company in the production of garments. Such fabric which is resold to other manufacturers outside the United States would be exported and would not enter the Customs territory. Such fabric which is resold to domestic manufacturers would be assessed duty based on the total yardage shipped, without any adjustments for damages. This is so, you state, because these fabrics are sold on an "as is" basis.

For purposes of this ruling, we assume that the fabric under consideration is dutiable on the basis of its value (i.e., not on the basis of its quantity). This is indicated to be the case in the schematic of procedures referred to in the July 1, 1991, letter from the Deputy Assistant Director, OTEXA, to the Executive Secretary, FTZ Board, a copy of which you provided us.

ISSUES:

(1) Upon removal of fabric from a foreign trade subzone into the Customs territory, may allowance be granted for shrinkage of the fabric effected by a shrinking process in the subzone?

(2) Upon removal of fabric from a foreign trade subzone into the Customs territory, may allowance be granted for defects in the fabric when the defects are found by examination in the subzone and are marked in the subzone but the defects are not cut out of the fabric until after it is removed from the subzone into the Customs territory?

LAW AND ANALYSIS:

It is a basic concept of Customs law that articles which are imported into the United States are classified and duty is assessed on the basis of their condition when they are imported into the United States, not on the basis of what their condition may become after being imported into the United States (United States v. Citroen, 223 U.S. 407, 414-415 (1911), and cases cited therein; see also Simod America Corp. v. United States, 872 F. 2d 1572, 1577 (Fed. Cir. 1989)). An exception to this general rule is the Foreign Trade Zone Act of June 18, 1934, as amended (19 U.S.C. 81a et seq.) (see 19 CFR Part 146 for the Customs Regulations pertaining to foreign trade zones (FTZ's)). Under section 3(a) of this Act (19 U.S.C. 81c(a)), merchandise may be brought into a FTZ and its classification and dutiability may be delayed until it, or merchandise resulting from its manufacture or manipulation, is brought into the Customs territory of the United States. Such merchandise is called non-privileged foreign status merchandise.

In the first proviso of section 3(a) of the FTZ Act, the FTZ Act also provides for the privilege of having merchandise brought into a FTZ classified and duties and taxes thereon calculated at any time before the merchandise is manipulated or manufactured, if such a privilege is requested. Such merchandise is called privileged foreign status merchandise. The legislative history to this provision, as well as the clear wording of the statute, make it very clear that the appraisement, classification, and liquidation of duties on foreign merchandise when privileged foreign status is granted are final and, "once made, would thereafter govern the dutiable and taxable status of the merchandise whenever it was sent into customs territory, whether or not it had been manipulated or manufactured in the zone in the meantime" (see Sen. Report 1107, 81st Cong., 1st Sess. (1949) (printed at 1950 U.S. Code Cong. Serv. 2533, see pp. 2535-2536)). Also under this proviso, allowance is to be made for recoverable or irrecoverable waste resulting from the manufacture or manipulation of privileged foreign status merchandise in a FTZ. If such recoverable waste is sent into the Customs territory it is classifiable and dutiable in its condition, quantity, and weight at the time of entry.

The Customs Regulations concerning FTZ's are found in 19 CFR Part 146. The regulations concerning the classification, valuation, and liquidation of merchandise transferred from a FTZ into the Customs territory are contained in 19 CFR 146.65. This section provides that privileged foreign status merchandise is subject to tariff classification according to its character, condition and quantity, at the rate of duty and tax in force on the date of filing, in complete and proper form, the application for privileged status. Non-privileged foreign status merchandise is subject to tariff classification in accordance with its character, condition and quantity as constructively transferred to the Customs territory at the time the entry or entry summary is filed. The dutiable value of privileged or non-privileged foreign status merchandise is the price actually paid or payable for the merchandise in the transaction that caused the merchandise to be admitted into the FTZ, plus certain additions and less certain subtractions, and if there is no such price the dutiable value is based on an alternative determination provided for in section 146.65 (see recent amendments to 19 CFR 146.65(b)(2), effected by Treasury Decision 91-79).

In this case, the fabric is sent from the subzone into the Customs territory after it is shrunk (if it is subject to the sponging and stabilizing process) but before any waste is cut out. As such, it consists of a piece of fabric which, although it may be marked to indicate defects, is still fabric with defects. Only after the fabric is cut, is there both fabric and scrap or defective fabric. Since the cutting takes place after the fabric leaves the subzone, allowance for defects may not be granted under the statute. Neither may any allowance for shrinkage be allowed, because the dutiable value of the merchandise would be based on the price paid or payable for the merchandise in the transaction that caused the merchandise to be admitted into the FTZ, with certain adjustments not pertinent to this discussion (see 19 CFR 146.65(b)(2)). (Note, that the merchandise under consideration is dutiable on the basis of its value (ad valorem).)

For your information, General Note 5 of the Harmonized Tariff Schedule of the United States Annotated (HTSUSA) has no application in this case. That provision provides that when goods subject to different rates of duty are packed together or mingled so that the quantity or value of each class of goods cannot be readily ascertained by Customs, the goods shall be subject to the higher rate of duty unless, in addition to certain other conditions, the consignee segregates the goods within a provided period of time under Customs supervision. In this case, when the fabric leaves the subzone it is not two classes of goods commingled, it is, as stated above, only one class of goods, i.e., fabric. Only after defects are cut out may there be two classes of goods.

As stated above, we understand that the FTZ Board is considering an alternative to the operation you describe in your ruling request. Under this alternative operation, fabric would be cut in the FTZ and defective and non-defective fabric would be segregated in the FTZ. The fabric would be subject to quota and visa requirements at the time of admission to the FTZ. Privileged foreign status would be required to be elected on all fabric admitted into the FTZ. Duties would be based on the full value of the fabric in the condition and quantity at the time of admission to the FTZ, except for the material that is found to be defective (we understand that defective pieces or panels of fabric would also be removed from the FTZ as "seconds"). Waste resulting from the cutting process ("cutting room scrap") would be determined to have no value based on application information and would be destroyed in the FTZ with the allowance reflecting this determination.

Our comments on the foregoing proposal follow. We understand that OTEXA may grant its approval to the operation, provided that privileged foreign status is elected at the time of admission of the fabric to the FTZ and the fabric is subject to quota and visa requirements as of the time of admission to the FTZ. Assuming that this is so, we would not object to this part of the alternative operation. Of course, election of privileged foreign status would result in the dutiability of the merchandise removed from the FTZ being based on its condition at the time of election of privileged foreign status. Defective fabric cut and segregated in the FTZ from non-defective fabric and removed from the FTZ as "seconds" would not be subject to any allowance and would be dutiable on the basis of its condition at the time of election of privileged foreign status because such "seconds" are expressly excluded from the category of textile waste by the Explanatory Notes to the Harmonized Tariff Schedule of the United States (19 U.S.C. 1202), heading 6310. Although "cutting room scrap" resulting from the cutting of non-defective fabric may qualify for the allowance provided for in the FTZ Act, we understand that OTEXA is opposed to the granting of any such allowance.

HOLDINGS:

(1) Upon removal of fabric from a foreign trade subzone into the Customs territory, allowance may not be granted for shrinkage of the fabric effected by a shrinking process in the subzone.

(2) Upon removal of fabric from a foreign trade subzone into the Customs territory, allowance may not be granted for defects in the fabric when the defects are found by examination in the subzone and are marked in the subzone but the defects are not cut out of the fabric until after it is removed from the subzone into the Customs territory.

Sincerely,

John Durant, Director
Commercial Rulings Division