Ruling of the Week 2016.23: Patents and Value

We don't talk enough about customs value here. It is important, complicated, and interesting. It deserves more attention. There are, however, also fewer rulings and cases on valuation questions. Happily, this one (HQ H233376, Sep. 19, 2016) caught my eye. The issue is whether a royalty paid to a U.S. patent holder who is unrelated to the importer is dutiable when the royalty is paid not by the importer but by the importer's parent company.

The patents at issue are all utility patents, meaning that they relate to new and useful inventions rather than to the design aesthetics of the item. A utility patent generally involves the critical technology that defines or empowers the invention. The license grants to the importer (via a predecessor company, just to complicate matters) "to make, have made, use, sell, offer for sale and import Licensed Devices" worldwide. The license also authorizes the licensee to disclose to the manufacturer, who is in Malaysia, the information that is necessary to manufacture the products. Similarly, the manufacturer is authorized to use the patented technology to makes the item and to apply related trademarks.

When goods are imported pursuant to a sale, the customs valuation is usually the "transaction value." That is defined at 19 USC 1401a(b) as the price actually paid or payable for the merchandise when sold for exportation to the United States, plus specified statutory additions including "any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States."

In 1993, Customs published an official notice detailing how it will analyze royalties for dutiability. We discussed that here. To summarize from my earlier post, under the test, Customs and Border Protection analyzes each royalty agreement on a case-by-case basis and asks three questions:

1. Was the importer merchandise manufactured under patent? If the answer is yes, then the payment is more closely tied to the production of the merchandise and is, therefore, more likely dutiable.

2. Was the payment involved in the production or sale of the imported merchandise? This question goes more deeply into the purpose of the payment. If the importer can show that the payment is for something other than the manufacture, production, or purchase of the imported goods, the payment may not be dutiable. Customs gave two examples in which the Court found that the putative royalty was for the use of the product in the United States, not for the patent rights related to the production or importation of the product. A positive answer to this question, therefore, leans toward dutiablity while a negative answer leans against.

3. Could the importer buy the product without paying the fee? If the fee is not optional and goes to the seller, it is more likely to be a dutiable part of the value of the merchandise. According to Customs, this question "goes to the heart" of whether the payment is a condition of sale. That means a negative answer to this question indicates dutiability.

In this ruling, Customs gave the short answer that the royalty is dutiable. The merchandise was manufactured under a patent and the patented technology is related to the production or sale of the imported item. Furthermore, Customs found that the importer could not buy the merchandise without paying the fee. Nevertheless, counsel for the importer (who was not me) argued against suitability of the royalty in this case.

Counsel first noted that the royalty is not paid to or for the benefit of the seller. This is a common argument and merits attention. How is a royalty part of the "price paid or payable" for the merchandise if it not paid to the seller? The answer is that the statute does not require that the royalty be paid to the seller to be dutiable. Rather, the statute requires that royalties be added to the dutiable value when they are "related to the imported merchandise" and when "the buyer is required to pay [the royalty], directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States." Note that the statute does not say to whom the royalty must be paid to be dutiable.

The question is not how much did the seller receive in exchange for the goods. The question is what is the total cost to the buyer to acquire the merchandise. This is entirely consistent with other parts of the statute which, for example, add assists, selling commissions, and packing materials to the entered value for duty. If the buyer did not pay this patent royalty, the seller would have to do so to acquire the legal right to manufacture the item. Because the buyer's parent paid it, the cost to the seller is reduced below what it would otherwise have been. This is exactly why the value of buttons provided by the buyer to the manufacturer for use in the production of shirts must be added to the entered value of the shirts. If the seller had to go buy the buttons, it would increase the price to cover the additional expense. This, therefore, is a losing argument, even when the patent holder is in the U.S.

To stick to this conclusion, Customs had to distinguish several prior rulings that appear to have conflicting results. I'm going to spare you the details. It should suffice to say that a patent royalty might not be dutiable if it is not a condition of the sale to the United States or is not fundamental to the manufacturer of the item. For example, a patent license relating only to the use of some item, as opposed to the manufacturer of it, is less likely to result in a dutiable royalty. Similarly, a design patent is less likely to be dutiable than is a utility patent.

The other question is whether a royalty paid to a U.S. patent holder can be a condition of the sale for export from the foreign manufacturer. After all, what does the manufacturer care if the buyer fails to pay the royalty? That is not its problem. Customs' analysis is more nuanced than that. It held that a condition of the sale exists where the right to use the patent "must be secured, either by the buyer or the manufacturer because the patent is necessary to produce the merchandise to be sold for export to the United States. i.e., [sic] the imported merchandise would not exist it the rights to the patent were not obtained." This gives the requirement that the royalty be a condition of the sale a broad and flexible interpretation that can be interpreted practically as well as under the terms of an individual contract.

All of that led Customs and Border Protection to hold the royalty in this case to be dutiable.

I have a question. The ruling clearly says, "the royalty payments at issue are made to the licensor, [Company A] (a U.S. patent holder who is not related to the company or to the manufacturer of the imported merchandise_, by [Company B], the parent of the company's parent." [Emphasis added.] So am I correct that the buyer did not actually pay this royalty? It was paid not by the parent company but by the grandparent company. This should be discussed in the ruling. The company, presumably the importer, is not responsible for the payment of the royalty. It seems possible that the company did not even know about it.

The statute covers "any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale . . . ." [Emphasis added.] It appears that Customs treated the royalty as indirectly paid, without stating so. Is that right?

I would read "indirectly" as relating to the method of payment to the seller, not to the party making the payment, which seems to be limited to the buyer. How do we know from this ruling that the buyer is required to make this payment, whether directly or indirectly? It seems clear that a related but legally separate entity is required to make that payment. I can see CBP's implied conclusion that this is an indirect payment by the buyer, but I think there needs to be some facts stated to support that conclusion. Otherwise Customs has effectively ignored the separate legal status of the companies and pierced a corporate veil without comment.

Final Exam 2016: Identity Crisis Edition

You may recall that last year my final exam for Trade Remedies was an elaborate, cinematic fact pattern involving the DC superhero universe. See here for that. Read the comments, which are really quite good.

This year, I was not able to string together quite as detailed a fact pattern for my Customs Law class. I did, however, ask this question. Tell me what you think is the correct answer. I will be flexible, but you should not need to stretch too much.

I'll be back soon. I promise.


QUESTION 3: 25 POINTS

Ralph Dibny is the CEO of Plastico, which imports plastic in various forms from suppliers all over the world into the United States. To find suppliers, Ralph relies on two representatives. Reed Richards is responsible for suppliers in South America. Patrick “Eel” O’Brian is responsible for suppliers in Asia. Neither representative is an employee of Plastico.

When Plastico wants to purchase materials from South America, Dibny contacts Richards who then finds suppliers that can provide the necessary material. Richards facilitates the transaction by locating and approving suppliers to Plastico’s standards, creating Plastico Purchase Orders, reviewing supplier invoices for Plastico, approving payment by Plastico, and arranging transportation. For these services, Richards earns a fee of 5% of the invoice price Plastico pays to the supplier. That amount is not shown on the commercial invoice for the imported product and has not been declared to Customs as part of the dutiable value of the merchandise.

Purchasing from Asia is a different process. Eel O’Brian has relationships with several plastic manufacturers throughout Asia. When a manufacturer in Asia has excess inventory, it contacts O’Brian and asks him to sell it to customers in the U.S. The supplier dictates the lowest acceptable price and usually refuses to take responsibility for the cost of shipping and transportation insurance, which must be paid by the customer, including Plastico. O’Brian will then contact Dibny and offer the merchandise to Plastico. If Plastico wants to purchase the merchandise on O’Brian’s terms, it agrees to purchase it from O’Brian. At that point, Plastico will create a Purchase Order naming O’Brian as the supplier. O’Brian places the order with the supplier, who ships the merchandise directly to Plastico in the United States according to the terms of Plastico’s P.O. with O’Brian. The supplier invoices O’Brian who then sends Plastico an invoice showing O’Brian as the seller and including a markup to add his profit. Plastico may not know the identity of the supplier until it receives the shipment, if even then. O’Brian has similar arrangements with several U.S. customers. He negotiates prices with the U.S. customer to maximize his income. The O’Brian’s markup is included in the commercial invoice used for entry and, therefore, has been declared to Customs as part of the dutiable value of the merchandise.

Plastico is always the importer of record and is not related to Richards, O’Brian, or to any foreign manufacturer of plastics. Transaction value is the applicable basis of appraisal.

Dibny has asked for your legal advice on whether the fee paid to Richards and O’Brian’s markup are legally part of the dutiable value of the merchandise. Dibny also wants to know whether there are adjustments Plastico can make to ensure that the amounts paid to Richards and O’Brian’s markup are not dutiable.

Ruling of the Week 2016.5: Kaboom! Project Management Fees

There used to be a time when I was able to keep this blog up, make each post funny, and occasionally interesting to the customs compliance pros. But, as periodically happens, then I get busy. It turns out that this is week 8 of 2016 and I am about to post ROTW number 5. I am not happy about that. Let's see what we can do to catch up.

Today's ruling is HQ H270670 (Feb. 17, 2016) and continues our focus on value questions. Value is complicated enough to make many compliance professionals quake.

The ruling involves purchases by "The Cereal Company" of premiums or toys. The only Cereal Company I can find online purports to be in Zambia. Thus, my assumption is that the Cereal Company is a pseudonym for an actual cereal company and that these toys are headed into boxes of puffed sugar and artificial color.

This case is honeycombed with players. The Cereal Company buys the toys from suppliers in China. An unrelated third party in the U.S. called Insight Promotions arranges for the toys to be wrapped and performs project management and testing. To save on alpha-bits, I will call that company "Insight." Insight outsources the wrapping to a third company in Canada called Econopac. Consequently, the goods go from China to Econopac in Canada and then to the United States. Econopac does not purchase the goods and does not have title. It invoices Insight for its services.

Insight Promotions performs additional services on behalf of the Cereal Company. Those include consultation about the toy design, communication with the manufacturer about production, testing, consultation with the buyer about packaging, management of the packing process, etc. According to Customs, the Cereal Company "reimburses" Insight for these services. I think the better term is "pays." Although, Insight may be reimbursed for the services from Econopac, assuming it pays Econopac.

For some reason, the Canadian Econopac is the importer into the United States. Think about that for a moment. Econopac does not own the goods, it is a toller providing services. The Cereal Company needs the merchandise and is the purchaser. Insight is supposed to be managing the process for The Cereal Company. There may be a perfectly good reason why this is set up this way. But, to my way of thinking, the Cereal Company might want to have more control over the compliance of its supply chain. It is a kick in the head when there is a problem with an entry and the party with the greatest interest in the goods, which I am assuming is the Cereal Company, is not the importer and can't easily get involved in the issue. But, that is a side issue for another day.

At entry, Econopac declares the value to be the sum of the following pebbles of value:

• The price paid by the Cereal Company for the toy
• Econopac's fee for wrapping
• The value of the wrapping material (plastic film)
• The additional fees for services charged by Insight

The question raised in the ruling is whether the additional services provided by Insight in the U.S. should be part of the dutiable value.

Uncle Sam, through U.S. Customs and Border Protection, assumes that the proper method of appraisal is transaction value. That means that the dutiable value will be the "price actually paid or payable for the merchandise when sold for exportation to the United States." That is, in other words, the total payment made for the merchandise by the buyer to or for the benefit of the seller.

Here, the payment to Insight is not a payment to the seller of the imported goods. The goods were sold by the supplier in China to the Cereal Company. Insight and Econopac were service providers, not sellers. On top of that, the services Insight provided were not closely related to production. It did not design the item nor did it provide manufacturing or production expertise. The payments to Insight, therefore, are not art of the price paid or payable for the imported merchandise. Which, I can say without waffling, is a good result.

Ruling of the Week 2016.3: Deductive Value

I tend to get focused on classification here on the Customs Law Blog. But, this is not the Tariff Classification Law Blog. Our scope if broader. With that in mind, we should also look at the other side of the duty calculation: value. Most importers understand that value is usually "transaction value" plus statutory additions including assists, royalties, and commissions. Look at 19 USC § 1401a. Most of the time, that will get you through the day. But, it does not work when you don't have a sale for export to the United States or when the price is affected by the relationship between the parties. In those cases, we need to turn to an alternative method of valuation.

When transaction value fails, the statute requires that the goods be appraised based on a hierarchy of methods. The first alternative is the transaction value of identical or similar merchandise. For purposes of today, I am skipping that and going to deductive value. Why? Because its my blog.

The ruling for today is HQ H007667 (May 25, 2007). The merchandise is melons imported from Panama. At the time of entry, the melons were not sold to the importer. Rather, they were entered on consignment. After delivery, the importer took possession of the melons and advanced the grower $2 per box, but did not buy them. Rather, it sold them unrelated third parties, usually within a week of arrival. After the sale (which is the first time a sale in the U.S. occurs) the importer payed the grower the proceeds of the sale, less adjustments for delivered quantity, marketing and distribution expenses, customs duties, and an overhead charge. Essentially, the importer was acting as an agent for the grower by selling goods in the U.S. and being compensated for expenses plus a commission.

Under these facts, there is no sale for export to the United States. Consequently, there is no price paid or payable at the time of entry and no basis on which to apply transaction value. The ruling does not give a particularly cogent reason for skipping from identical or similar merchandise to deductive value. The issue seems to have been price volatility, but that is not important. We are looking at the deductive value analysis.

Deductive value starts with the sale price in the U.S. and deducts out expenses to try and arrive at an FOB foreign port price. The relevant sale price is the unit price at which the merchandise concerned is sold in the greatest aggregate quantity at or about the date of import. If the merchandise is not sold at or about the time of importation, the relevant price is the price at which the merchandise was sold in the greatest aggregate quantity after the date of importation but before the close of the 90th day after importation. That puts a stake in the ground setting the outermost limit for when a deductive value can be found. Here, the melons were to be sold within a week, which is at or about the time of importation.

Now, we have to back expenses out of that price to get to the entered value. According to 19 CFR § 152.105(d), the expenses to be deducted include:
           

1. Any commission usually paid or agreed to be paid, or the addition usually made for profit and general expenses, in connection with sales in the United States of imported merchandise that is of the same class or kind, regardless of the country of exportation, as the merchandise concerned;

2. The actual costs and associated costs of transportation and insurance incurred with respect to international shipments of the merchandise concerned from the country of exportation to the United States;

3. The usual costs and associated costs of transportation and insurance incurred with respect to shipments of the merchandise concerned from the place of importation to the place of delivery in the United States, if those costs are not included as a general expense under paragraph (d)(1) of this section;

4. The customs duties and other Federal taxes currently payable on the merchandise concerned by reason of its importation, and any Federal excise tax on, or measured by the value of, the merchandise for which vendors in the United States ordinarily are liable; and

5. But only in the case of price determined under paragraph (c)(3) of this section, the value added by the processing of the merchandise after importation to the extent that the value is based on sufficient information relating to the cost of that processing.

In the melon ruling, counsel for the importer proposed several deductions including:

1. Profit and general expenses related to the sale in the U.S. (including the commission)

2. International shipment from Panama to the U.S.

3. Customs duties, MPF and HMT and the cost of phytosanitary certificates

Customs allowed the deduction for marketing and distribution costs as well as the profit. Profit, in this case, was expressed as an "overhead charge." Customs also allowed the deduction for ocean freight. Because the transportation from Panama to the inland point of unloading in the U.S. was shown on a single through bill of lading, Customs permitted the domestic transportation to be deducted. Finally, the customs duties, taxes and fees could be deducted.

After all of those deductions, what remains is the deductive value. Calling it "deductive value" should kind of make sense now.

The interesting thing about deductive value is that it inverts the recordkeeping requirements. The importer is still required to retain documents to support valuation, but the nature of those documents will change. Under deductive value, the there is no price paid or payable to the exporter and there will not be an invoice from the exporter or payment to the exporter that corresponds to the deductive value. Rather, the key documents are evidence of the post-importation sale in the U.S. and, very critically, evidence supporting any deductions from that sale price. An importer relying on deductive value needs records proving the cost of international shipment; the duties, taxes, and fees paid; marketing and distribution expenses; the profit it earned; etc.

This is sometimes a hard concept for compliance personnel who are used to matching a commercial invoice to a 7501 and payment record. It is, however, the way it works.

Some of you are screaming that I skipped over the issue of finding the price at the greatest aggregate quantity. That is an important issue and also impacts recordkeeping. What it means is that your starting price cannot be arbitrarily selected as the lowest price ever attained in the U.S. That would be inappropriate and not representative of true value.

Instead, the price to use as the starting point for your deductions is the single most common price at which the units are sold to an unrelated party. Assume you import 100 melons and make four sales: 15 units for $2 each, 10 units for $1.50 each, 40 units for $1 each, and 35 units for $1.50. Although the single largest sale was of 40 units for $1 each, that is not the price to be used. Rather, the price of the greatest aggregate quantity is $1.50, which was applied to the sale of 45 units (10 + 35). Yes, that is a recordkeeping issue as well.

Ruling of the Week 2015.29: Hasbro II, Royalties and Proceeds

Continuing my exploration of classic Customs and Border Protection rulings, we come to the confounding "General Notice" called Hasbro II. It was published at 27 Cust. B. & Dec. No. 6 (1993). Customs does not have Customs Bulletins online from that far back, so I put a copy here for you to read.

The issue arises from a ruling request concerning an apparent royalty payment. Hasbro, as the importer/buyer of merchandise agreed to pay the seller 7% of the resale invoice price of the imported goods. Presumably, in addition to the original purchase price, the contract requires Hasbro to pay an addition amount to the seller equal to 7% of whatever price Hasbro gets for the goods on resale in the U.S.

It seems fairly obvious that the 7% second payment, which is included in the purchase contract, is part of the total price paid or payable for the imported goods. That would tend to make it dutiable.

But, the law requires specificity. If the payment is not "for the merchandise when sold for exportation to the United States," it can only be added to the dutiable value if the statute specifically allows for it. On possibility is that the payment is the "proceeds of any subsequent resale . . . that accrue, directly or indirectly, to the seller." That would be dutiable under 19 U.S.C. 1401a(b)(1)(E). The other possibility is that the payment is a dutiable royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States." That is dutiable under 19 U.S.C. 1401a(b)(1)(D).

Initially, Customs found the distinction between these two provisions to be unclear. Given the ambiguity, Customs looked at the legislative history to try to divine what Congress intended. Regarding proceeds of subsequent resale, the Statement of Administrative Action (which is how the White House explains a trade bill to Congress) stated only that to be dutiable the proceeds must related directly to the imported merchandise and that Customs should make the decision on a case-by-case basis.

Regarding royalties, the SAA was much more detailed. First, royalties related to patents covering processes to manufacture the imported goods will generally be dutiable. This makes sense given that the value of the royalty is access to the technology or know-how necessary to make the very product that is being imported.

On the other hand, royalties paid to third parties (i.e., not the seller) for the use in the United States of copyrights and trademarks related to the imported merchandise will generally be treated as the buyer's selling expenses (e.g., domestic marketing) and not dutiable. This also makes sense in that the product name or logo may be valuable from a branding perspective, but they do not necessarily reflect the intrinsic value of the merchandise sold by the seller. But, that is not always the case. If the payment is to the seller and the buyer is required to make the payment as a condition of the sale for exportation to the United States, then the fee is closely tied to the acquisition of the physical merchandise and may be dutiable. This also requires a case-by-case analysis.

After reviewing the legislative history, Customs turned to an analysis of court decision under the prior law. In summary, those decisions found that three questions help determine whether a payment is a dutiable royalty. Those questions are:

1. Was the importer merchandise manufactured under patent? If the answer is yes, then the payment is more closely tied to the production of the merchandise and is, therefore, more likely dutiable.

2. Was the payment involved in the production or sale of the imported merchandise? This question goes more deeply into the purpose of the payment. If the importer can show that the payment is for something other than the manufacture, production, or purchase of the imported goods, the payment may not be dutiable. Customs gave two examples in which the Court found that the putative royalty was for the use of the product in the United States, not for the patent rights related to the production or importation of the product. A positive answer to this question, therefore, leans toward dutiablity while a negative answer leans against.

3. Could the importer buy the product without paying the fee? If the fee is not optional and goes to the seller, it is more likely to be a dutiable part of the value of the merchandise. According to Customs, this question "goes to the heart" of whether the payment is a condition of sale. That means a negative answer to this question indicates dutiability.

Customs found that these questions provide a useful analytical approach under the current law.

Turning bask to the case at hand, it was unclear whether the product was made under patent, but the agreement gave the buyer the right to manufacture it. That is close to a "yes" on question one. Customs found that the 7% payment obligation accrued upon the sale of the product, regardless of when the buyer actually collected the sale price from its customer. Under these facts, Customs held the payment to be a dutiable royalty.

But wait, there's more!

Customs also said that the same payment can be analyzed separately to determine whether it is also the proceeds of subsequent resale. Here, the obligation to pay was based on the resale price. According to Customs, part of the income the buyer derived from the subsequent resale accrued to the seller. It is, therefore, dutiable as proceeds.

This ruling has had significant practical consequences. Not the least of which is that Customs and Border Protection takes royalties and license fees very seriously when conducting audits. A typical early step is an audit is for Customs to request a Chart of Accounts. From there, Customs will identify accounts labeled as "Royalties," "License Fees," "Commissions" and similar items. It will then ask to see activity in those accounts and expect either proof that the amounts were declared or an explanation as to why not.

This means that importers need to be aware of the compliance impact of royalties, license fees, proceeds, and similar mechanisms. Purchasing people need to communicate with compliance staff to ensure that dutiable royalties are declared and non-dutiable payments are properly vetted and documented. If the company has in-house lawyers, those who work in intellectual property fields should be fully briefed on this and should alert the compliance team to new agreements.

Finally, when in doubt, get a ruling.

Ruling of the Week 2015.27: Prototypes and Double Taxation

This is a review of what I will call a "classic" Customs and Border Protection ruling about which everyone in the trade should be familiar. In this case, we are talking about HQ 545907 (Oct. 11, 1996), which is the reconsideration of HQ 545278 (Apr. 7, 1994).

This ruling involves a contract between Ford Motor Company and Yamaha Motor Company. Under the terms of the deal, Yamaha was to design and develop a modified Ford engine. Ford agreed that it would purchase any prototypes Yamaha made. If the program was successful, Ford agreed to enter into a contract for the purchase of the modified engines.

To develop the modified engine, Yamaha produced 178 prototypes, which were purchased by Ford. Ford imported 156 of the prototypes and paid duty on them based on the price paid to Yamaha. Note that this is 1996, before tariff item 9817.85.01 was added to the tariff. The program was a success and Ford started importing the engines.

The relevant question is whether the sums Ford paid to Yamaha for the prototypes, some of which were imported and subject to duty, are to be included in the value of the engines imported for purchase by Ford. In the initial ruling, Customs held that the payments for the prototypes were inextricably linked to the cost of developing the modified engine. As such, those payments for the prototypes were part of the price paid or payable for the production engines and, therefore, subject to duty again when Ford imported the engines.

Ford raised several good points. First, it pointed out that this result violates the principle against double taxation. Here, the prototypes have already been subject to duty based on their declared value. That value, according to Ford, should not be subject to duty again. That is obviously true as it creates a disincentive to perform any part of the testing in the U.S. Had Ford tested them in Japan, this would never have been a problem.

In the request for reconsideration, Customs stuck to its original position. According to Customs, payments for the development of samples and prototypes are usually considered to be part of the price paid or payable for the subsequent production merchandise. Here, the prototypes were inextricably linked to the cost of developing the new engines. As such, payment for the prototypes are part of the total price paid for them. Because the prototype engines were not returned to Yamaha, they were not assists. But, the payments remain part of the total price paid or payable for the final production engines.

Most of the sting of this ruling has been mitigated by the addition of HTSUS item 9817.85.01, which provides for duty free entry of "Prototypes to be used exclusively for development, testing, product evaluation, or quality control purposes . . . ." There are a number of relevant Chapter Notes regulating the application of this provision. When trying to use 9817.85.01, be sure that the merchandise legally qualifies as a prototype for development, testing, etc. A similar result could be accomplished by using a Temporary Importation Bond or possibly drawback (if the prototypes or equivalent products are exported or destroyed).

Despite there being several strategies by which to avoid this issue, it continues to surprise some people that this is the rule. Companies that do not have good policies and procedures for handling prototypes can end up with a big, unexpected duty bill. This can happen when engineers, for example, arrange for prototypes to be shipped directly to them, outside of the normal compliance process. Don't let that happen. If your company imports prototypes, samples, evaluation items, ofr similar pre-production goods, make sure there is a well-published and understood process to making those entries. And, be sure to let your broker know that a shipment contains prototypes. A bit of upfront work on this front can avoid significant headaches later.

CBP Extends a Helping Hand

If you were in customs compliance during the Clinton-years, you might remember Customs and Border Protection taking the public position that it was in the business of facilitating legitimate trade and that it would be a "kinder and gentler" agency. U.S. government people actually said that, or possibly I dreamed it. To me, it is real.

That was before 9/11/2001, the creation of the Department of Homeland Security, and the shift toward border security as an existential issue of national security. By which I do not mean to denigrate that position at all. CBP's security job is important.

Today CBP announced a possibly small program that is 100% in line with the kinder, gentler agency of yore and helps to facilitate U.S. exports. That's good for the economy.

The program is the opportunity for exporters to request assistance on tariff classifications and customs valuation in other customs territories. Here is the pre-publication notice. It should show up in the Federal Register tomorrow (meaning June 18, 2015).

This notice seems to be formalizing a practice that previously existed. If a U.S. importer or exporter identified inconsistent treatment in another country or customs territory, U.S. Customs and Border Protection has always had the ability to bring that issue to the attention of the proper WCO committee. What is new is that CBP is publicizing that this opportunity exists as a means of fostering greater collaboration with industry. Customs is also saying that it can address the issue directly with the other country.

For conflicts that raise a real substantive issue, CBP says it will endeavor to provide an initial response within 60 days and will keep the relevant party informed thereafter.

This is a potentially valuable program and, also, a genuinely nice thing. Thanks.

Thank You, Otterbox

As previously discussed, the tariff classification of plastic cases for mobile phones, tablets, and similar electronic devices has been subject to much dispute. Customs and Border Protection has long held that they are usually, but not always, classified in Heading 4202 as if they are trunks, attaché cases, or musical instrument cases. I previously explained, in a fair amount of detail, why I think this is wrong. Turns out, barring interventions from the Court of Appeals, that I was right. Being right is a circumstance that always makes me happy.

In a thorough and thoroughly well reasoned decision, the Court of International Trade has decided that cases for iPhones and similar products imported by Otter Products ("Otterbox") are not classified in Heading 4202. Rather, they are articles of plastic in Heading 3926.

Customs had classified the goods in 4202 on the basis of Note 2(m) to Chapter 39, which excludes from Chapter 39 "containers" of Heading 4202. The primary question, therefore, is whether the cases are containers of 4202. Specifically, to be excluded from 3926, the containers would have to be "similar" to the exemplars in the first clause of Heading 4202, including "[t]runks, suitcases, vanity cases, attaché cases, briefcases, school satchels, spectacle cases, binocular cases, camera cases, musical instrument cases, gun cases, holsters and similar containers." To do that, the cases would have to have the same essential characteristics and purposes that unite all of the items in the list. According to prior court decisions, that means that the cases must be useful for organizing, storing, protecting, and carrying the contents of the case.

Before jumping into an analysis of those four factors, the Court of International Trade took the wise step of looking at the bigger picture. Are these cases even "containers?" If not, they cannot be similar containers.

The government proposed various definitions of "container" as things that contain or enclose other things. These definitions included examples such as boxes, crates, and jars. While the list of examples is not complete or dispositive, it does illustrate the nature of a container as something that completely encloses an article in a way that makes it inaccessible without some effort to open the container. That is not true for an iPhone case. When fully "encased," the iPhone remains completely accessible and useful to the owner. That is important. An iPhone in an Otterbox case is not "put away" like dried beans in a can or dirty socks in a suitcase. I cannot wear my socks (clean or dirty) when they are in a trunk. I cannot read my newspaper when it is in my attaché case. Thus, an iPhone case is not a container.

It seems to me that the Court might have stopped there. If these cases are not containers, they are not "similar containers." But, to avoid any confusion for later proceedings, the Court analyzed the four factor test as well. On that front, both parties agreed that the cases at issue "protect" the electronic devices. That is not disputed.

But, the cases do not provide any organizational functionality at all. There is no organizational difference between your phone in a case and your naked phone. You can lose it just as easily and the cases do not facilitate holding any other items with the phone. "Organization" is the act of putting more than one item in some kind of useful order. These cases do not do that.

Nor are they useful for storing the phone or other device. To "store" something is to put it away for later use. These cases are designed to permit use while inside the case. Thus, they are not for storage.

Regarding the feature of "carrying" the contents of the case, the Court noted evidence that some of the cases included a belt clip for the fashion impaired. While the belt clip may facilitate carrying the phone, it is not always used. Further, and this is my thought, the phone continues to be fully functional while clipped to a belt. In fact, it is there so that the owner can get a call, possibly from a stylist or from Steve Urkel. This was not an important factor.

What was important is that the function of continuing to be fully functional while inside the case is inconsistent with all of the exemplars in Heading 4202. That divergent functionality separates the electronic cases from containers of 4202, some inconsistent Customs rulings notwithstanding.

That's that. A thorough, thoughtful, and to my way of thinking, correct analysis of the tariff classification of plastic electronic cases.

There is a second and also interesting point in this case.

The protests in this case were addressed to the classification question. In Court, the plaintiff sought a refund based on the change in tariff classification applied to the full value of the merchandise including an assist voluntarily disclosed after the time of entry. I suspect, but do not know for certain that this disclosure relates to the False Claims Act case involving Otter Products. According to the government, because the assist was voluntarily paid, it was not a "charge or exaction" subject to protest.

The Court started with the proposition that because CBP must liquidate an entry at the correct classification by applying the corresponding rate of duty to the correct value, a protest of the classification applied at liquidation necessarily requires a determination of the correct value to be applied to the rate of duty. That makes perfect sense. When CBP refunds the overpaid duties as a result of the change in classification, it should refund all of the excess duties paid. That necessarily includes the duty on the disclosed assist. Customs will presumably keep that portion of duty owed on the assist at the lower rate of duty. The issue here is not that Otterbox is disputing the appraised value of the merchandise. The issue is that any refund should be calculated on the undisputed value of the merchandise, which includes the assist.

Nice work Otterbox. High five.