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HQ 224628


January 10, 1994

FOR-2-05-CO:R:C:E 224628 PH

CATEGORY: FOREIGN TRADE ZONE

William J. Phelan, Esq.
Phelan & Mitri
1177 Summer Street
Stamford, Connecticut 06905

RE: Foreign Trade Zone; Vessel and Aircraft Supplies; Jet Fuel; Accounting Systems; 19 U.S.C. 81c; 19 U.S.C. 1309; 19 CFR 10.59 through 10.65; 19 CFR 146.21, 146.23, 146.25, 146.53, 146.69, 146.71; C.S.D. 82-152; C.S.D. 81-67

Dear Mr. Phelan:

In your letter of March 31, 1993, you requested that Customs authorize an accounting and identification procedure described in the materials you submitted with your letter for removal from foreign trade zones (FTZ's) of jet fuel for use on foreign and domestic flights. Our ruling follows.

FACTS:

A FTZ would be established at an international airport. The FTZ would consist of the tanks and pipelines systems designed for the storage and delivery of jet fuel to aircraft. We assume, for purposes of this ruling, that all conditions and requirements imposed by the FTZ Board (see 19 U.S.C. 81a et seq.) are met.

It is proposed that Customs authorize a procedure which would permit the commingling in common storage of privileged foreign, non-privileged foreign, and domestic jet fuel. The jet fuel so commingled would be the property of, and would be used by, more than one airline. It is proposed that identification of the fuel removed from the commingled storage be permitted so that domestic fuel would be considered removed for use on domestic flights and privileged and/or non-privileged foreign fuel would be considered removed for use on flights qualifying for duty-free treatment under 19 U.S.C. 1309.

You describe the records which are proposed to be used and provide sample records for demonstration purposes. These records would include "Daily Inventory Records" for foreign and domestic fuel showing for each airline-- 1. Opening inventory.

2. Receipts into the FTZ (these receipts would show the status (i.e., domestic or privileged or non-privileged foreign; we note that there would be separate daily inventory records for foreign and domestic fuel) and the source of the fuel (i.e., either a FTZ refinery or an import, for the foreign status fuel)). Each receipt of jet fuel would be assigned a unique identification code which would follow all quantities of that fuel through all FTZ activities.

3. "Transfers out" (i.e., sales within the FTZ to other airlines; such transfers would be supported by routine commercial documentation (e.g., purchase orders, contracts, invoices)).

4. "Transfers in" (i.e., purchases within the FTZ from other airlines; see above in regard to documentation for such transfers).

5. Consumption of fuel for foreign (qualifying under 19 U.S.C. 1309) and domestic (non-qualifying under 19 U.S.C. 1309) flights (consumption would be supported by records of fuelings of individual aircraft (e.g., fueling tickets or alternate documentation)).

6. Closing inventory.

You state that fuel would be consumed and sold by each airline on a first-in, first-out (FIFO) basis according to the order of receipt of the cargoes into the FTZ, regardless of the order of receipt of separate quantities by the airlines (e.g., regardless of when fuel already in the FTZ was received in a "transfer in" from one airline to another). (We note that rather than being a true FIFO system (in which all commingled merchandise would be identified on a FIFO basis so that the merchandise longest in the common inventory was always the first removed, regardless of status), the proposed accounting procedure is actually for the identification of merchandise within a particular status and owned by a particular airline on a FIFO basis (e.g., even if the merchandise longest in common inventory was non-privileged foreign status jet fuel owned by airline A, and even if the merchandise owned by airline B which was longest in common inventory was non- privileged foreign status jet fuel, under the proposed procedure airline B could remove domestic status jet fuel and the jet fuel could be identified as jet fuel in that status owned by airline

You state that the airlines would manage their fuel inventories so that in the ordinary course of business the quantities of foreign and domestic fuel on hand would exceed the amounts transferred out or consumed for foreign and domestic flights, respectively. If an airline depletes its inventory of foreign (or domestic) jet fuel so that it does not have sufficient quantities to debit its daily consumption of foreign (or domestic) flights, the airline's domestic (or foreign) inventory would be debited as necessary to account for total consumption. Such quantities would be reported in the consumption data on the Daily Inventory Records. When an airline used foreign fuel on domestic flights, the airline would file a consumption entry and pay the appropriate duty. We understand, and assume for purposes of this ruling, that the entry would be made and applicable duties would be deposited in the 24-hour period immediately following the 24- hour period in which the foreign fuel was removed from the FTZ.

In addition to the Daily Inventory Records, the proposed accounting system includes "Monthly Inventory Summaries" which you state would summarize and total the data reported on the Daily Inventory Records. Separate Monthly Inventory Summaries would be maintained for foreign and domestic jet fuel. The records would show, for each airline and in total:

1. Opening inventories.

2. Monthly FTZ receipts.

3. Monthly transfers out.

4. Monthly transfers in.

5. Monthly consumption.

6. Closing "book" inventories.

You state that on the last day of each month, a physical inventory of all the fuel in the system would be taken and the "book" and "physical" quantities would be reconciled. Because foreign and domestic fuels are commingled, this reconciliation would be effected by attributing to foreign and domestic fuels the difference between the book and physical inventories on the basis of the percentage of foreign and domestic fuel in the closing book inventories for the month.

In the reconciliation procedure, if the physical inventory was greater than the corresponding book inventory, the "gain" would be distributed to each airline based on its percentage of total consumption of jet fuel during the month and the month's "gain" would be included in the appropriate opening inventory for the following month. If the physical inventory was less than the corresponding book inventory, the "loss" would be distributed on the same basis to each airline and the month's "loss" would be included in the appropriate opening inventory for the following month. "Gains" and "losses" would be attributed to foreign and domestic fuels as described in the immediately preceding paragraph.

ISSUES:

(1) Are the FTZ accounting procedures, provided for under current law and regulations, met in the described proposal?

(2) Are the procedures for removal from a FTZ, provided for under current law and regulations, met in the described proposal?

(3) Are the procedures for reconciliation of "book" and "physical" inventories and for attributing "losses" and "gains" in the described proposal in accordance with current law and regulations?

LAW AND ANALYSIS:

Under 19 U.S.C. 1309(a), "[a]rticles of foreign or domestic origin may be withdrawn ... from ... [a FTZ] free of duty and internal-revenue tax" for supplies of foreign or United States vessels or aircraft "actually engaged in foreign trade or trade between the United States and any of its possessions, or between Hawaii and any other part of the United States or between Alaska and any other part of the United States ... [except that the provisions for free withdrawals in this section are not applicable to petroleum products for aircraft in flights exclusively between Hawaii or Alaska and any United States airport]." The Customs Regulations pertaining to section 1309 are found in 19 CFR 10.59 through 10.65.

The statute governing the creation and operation of FTZ's is the Foreign Trade Zones Act of 1934, as amended (48 Stat. 998; 19 U.S.C. 81a through 81u). Under 19 U.S.C. 81c(a), foreign and domestic merchandise of every description (except prohibited merchandise) may be brought into a FTZ without being subject to the U.S. Customs laws and may there be, among other things, stored, mixed with foreign or domestic merchandise, or otherwise manipulated and be exported, destroyed, or sent into the U.S. customs territory. When foreign merchandise is so sent from a FTZ into U.S. customs territory it is subject to the U.S. laws and regulations affecting imported merchandise. Articles of the United States and articles previously imported on which duty and/or tax has been paid, or which have been admitted free of duty and tax, may be taken into a FTZ from the U.S. customs territory, placed under the supervision of the appropriate Customs officer, and, whether or not they have been combined with or made part of other articles while in the FTZ, be brought back thereto free of quotas, duty, or tax. If the identity of such articles (i.e., the "domestic status" articles described in the preceding sentence) has been lost, articles not entitled to free entry by reason of noncompliance with the requirements under the authority of this provision are treated as foreign merchandise if they reenter the customs territory. The Customs Regulations issued under the authority of this statute are found in 19 CFR Part 146.

We assume, for purposes of this ruling, that the requirements for admission into a FTZ are complied with in this case (see 19 CFR Subpart C and section 146.22). As stated above, we also assume, for purposes of this ruling, that all conditions and requirements imposed by the FTZ Board are met. At issue then, are the accounting procedures for the merchandise while it is in the FTZ, the procedures for removal of the fuel from the FTZ, and the procedures for reconciliation.

The general requirements for inventory control and recordkeeping in a FTZ are provided in 19 CFR 146.21. Under this provision, a FTZ operator is required to maintain inventory control and recordkeeping systems capable of: (1) accounting for all merchandise undergoing operations (listed in the provision) in a FTZ, including the admission into, storage in, and/or removal from a FTZ; (2) producing accurate and timely reports and documents as required by the applicable Customs Regulations; (3) identifying shortages and overages of merchandise in a FTZ in sufficient detail to determine the quantity, description, tariff classification, zone status, and value of the missing or excess merchandise; (4) providing all information necessary to make entry for merchandise transferred to the Customs territory; and (5) providing an audit trail to Customs forms from admission through transfer of merchandise from a FTZ either by zone lot or Customs authorized inventory method. Under 19 CFR 146.23(a)(1), which provides for the accountability for merchandise in a FTZ, a zone lot number or unique identifier is required to be used to identify and trace merchandise. Under paragraph (b) of this provision, inventory records are required to specify by zone lot or unique identifier the following information: (1) location of the merchandise; (2) zone status of the merchandise; (3) cost or value of the merchandise; (4) beginning balance, cumulative receipts and removals, adjustments, and current balance on hand by date and quantity; (5) destruction of the merchandise; and (6) scrap, waste, and by-products. Under paragraph (a)(2) of this section, fungible merchandise may be identified by an inventory method authorized by Customs which is consistently applied, such as FIFO, and using a unique identifier. Under paragraph (c) of this provision, the FTZ operator is required to take at least an annual physical inventory of all merchandise in the FTZ and to notify Customs of any discrepancies in accordance with 19 CFR 146.53 (see also 19 CFR 146.25, under which the operator is required to prepare an annual reconciliation report for Customs).

We have issued a number of rulings on the above requirements. In Customs Service Decision (C.S.D.) 82-152, we addressed the issue of "... whether the identity of the domestic jet fuel, privileged foreign jet fuel, and nonprivileged foreign jet fuel [in a FTZ] can be maintained after the mixing [in the FTZ] so that the portion of the combined product attributable to the domestic jet fuel may be returned to Customs territory free of duty." We held in the affirmative (i.e., a known volume of finished specification domestic jet fuel could be mixed in a FTZ with a known volume of finished specification foreign jet fuel and retain its identity as domestic jet fuel if the proportions of the domestic and foreign components were determined by independent volume measurements prior to their being mixed and assuming that it is possible to accurately and rationally calculate the quantity of domestic components in the mixture). See also, C.S.D. 81-67, holding similarly for the mixing, in specified quantities, and co-feeding of privileged domestic and non-privileged foreign crude oil into a distillation unit and the accounting for the resultant refined products (i.e., the resultant products were permitted to retain their zone identity if the quantities derived from each could be established through approved inventory control and accounting procedures) (note that C.S.D. 81-67 provides for the shipment of finished products "on a [FIFO] basis within each status, foreign or domestic ..." (emphasis added)).

Thus, Customs has permitted merchandise to retain its FTZ status in operations similar to that under consideration. We conclude, except in regard to the procedures for the physical inventory, reconciliation, shortages and overages (discussed below), that the accounting procedures described herein and in your submission meet current statutory and regulatory requirements.

Removal of merchandise from a FTZ is provided for in the Customs Regulations as described below. Under 19 CFR 146.62 and 146.63, entry is required for foreign merchandise which is to be entered for consumption. The general provisions for exportation from a FTZ are found in 19 CFR 146.67, under which transfers from a FTZ for direct exportation or transportation and exportation are required to be made on Customs Form 7512. Removals from a FTZ of merchandise under 19 U.S.C. 1309 are also required to be made on Customs Form 7512 (19 CFR 146.69). Under 19 CFR 146.43(b), no application or permit is required for the transfer to the Customs territory of domestic status merchandise except when it is mixed or combined with merchandise in another zone status (in this regard, note the above-cited rulings on how domestic status merchandise may retain its status when mixed with merchandise of another status). Under 19 CFR 146.71, no merchandise (with an exception inapplicable in this case) may be transferred from a FTZ without a Customs permit on the appropriate entry or withdrawal form or other document as required under 19 CFR Part 146.

We have considered the applicability of the statutes and Customs Regulations relating to Customs bonded warehouses (note that there also the filing of an entry or a Customs Form 7506 or 7512 is required before withdrawal of merchandise; see 19 CFR 144.31 - 144.39 and 10.60 and 10.62) in an analogous situation (letters dated October 20, 1989 (File: 221483), May 8, 1990 (File: 222258), and April 29, 1991 (File: 222914)). In these rulings, we permitted the transportation (after removal from a Customs bonded warehouse under 19 U.S.C. 1309) in a single hydrant fueling system of bonded jet fuel with unbonded jet fuel if (assuming strict controls and timely accounting) the fueling system was equipped with certain physical safeguards and if entry was made and duty paid for any quantity of bonded fuel which was introduced into the hydrant system when a like quantity was not loaded on a qualified (under 19 U.S.C. 1309) aircraft within 24 hours of the introduction of the bonded fuel into the hydrant system. We stated that we were willing to defer the collection of duties (required when the withdrawal from the warehouse for consumption was filed; 19 CFR 141.101(b))) for 24 hours. In an October 15, 1991, ruling (File: 223268), these rulings were applied to fuel transported from a FTZ and introduced into such a single hydrant system and it was made clear that the requirement for loading a qualified aircraft within 24 hours of the introduction of the bonded fuel into the hydrant system meant that the fuel must be so loaded in the same 24-hour period (defined as a 24 hour period beginning at 12:01 a.m. and ending at 12:00 midnight).

As indicated above, the above rulings may be applied to the situation under consideration (i.e., because the requirements for withdrawal from a warehouse are similar to those for removal from a FTZ; note that we applied the above-described single hydrant fueling system rulings to jet fuel removed from a FTZ under 19 U.S.C. 1309). Because in the situation under consideration the jet fuel is not removed from the FTZ until loading on aircraft, the safeguards in the physical layout of the hydrant system (e.g., check valves to prevent backflow) are unnecessary in this case. The proposal includes strict controls (i.e., the Daily Inventory Records for foreign and domestic fuel showing for each airline opening and closing inventories, receipts (with a unique identification code) into the FTZ, transfers in and out and commercial documentation supporting such transfers, and consumption of fuel for foreign and domestic flights supported by fueling tickets or similar documentation, as well as a monthly physical inventory of the fuel in the FTZ) and timely accounting. If an airline depleted its inventory of domestic jet fuel so that it did not have sufficient quantities for its consumption that day for domestic (non-qualifying under 19 U.S.C. 1309) flights, the airline's foreign inventory would be debited as necessary to account for the consumption of jet fuel on domestic flights. This would be reported on the Daily Inventory Record and the airline would file a consumption entry and pay the applicable duty in the 24-hour period immediately following the 24-hour period in which the foreign fuel was loaded onto the non-qualifying aircraft. Under the proposed accounting procedure, the airline's foreign inventory would be debited on the FIFO basis described above (i.e., foreign receipts, identified with a unique identification code showing FTZ status, would be debited on the basis of first received in the FTZ).

Based on the above discussion, we conclude that the proposed procedures for removal of fuel from the FTZ are permitted by current law and regulations (as interpreted by the above rulings).

As stated above, the Customs Regulations require a physical inventory of all merchandise in a FTZ at least annually. The FTZ operator is required to notify Customs of any discrepancies. The FTZ operator is also required to prepare an annual reconciliation report for the FTZ (19 CFR 146.23(c) and 146.25). The procedures for shortages and overages in a FTZ are set forth in 19 CFR 146.53.

Under 19 CFR 146.53(a)(3), a FTZ operator is required to report to Customs any shortage of 1 percent or more in the quantity of merchandise in a lot or covered by a unique identifier, if the missing merchandise would have been subject to duties and taxes of $100 or more upon entry into the Customs territory. Furthermore, the operator is required to record upon identification all shortages and overages, whether or not they are required to be reported as in the preceding sentence, in its inventory control and recordkeeping system, and to record all shortages and overages in its annual reconciliation report (see above). Under 19 CFR 146.53(c), the FTZ operator is responsible under its FTZ Operator's bond for shortages (unless Customs is satisfied that one of the listed excuses pertains). Upon demand by Customs, the FTZ Operator is required to make entry for and pay duties and taxes applicable to merchandise which is missing or otherwise not accounted for. In regard to overages, under 19 CFR 146.53(d), the person with the right to make entry of the merchandise shall file, within 5 days after identification of an overage, an application for admission of the merchandise to the FTZ or file a consumption entry for the merchandise (if such application of entry is not timely made, the merchandise is required to be sent to General order).

The procedures proposed for handling shortages (described as "losses" in the proposal) are not consistent with the above (i.e., in the proposal monthly "losses" would be attributed to foreign and domestic status fuel on the basis of proportionate use and would be distributed to each airline on the basis of its percentage of total monthly consumption). Under the Customs Regulations, these "losses" are the responsibility of the FTZ operator, who, upon demand by Customs, is required to make entry for and pay duties applicable to the fuel (Note: Customs would have no objection if the airlines participating in the proposed operation decided to apportion duties and taxes among themselves on the above basis, but the FTZ operator must be responsible to Customs, and has a bond guaranteeing to do so (see 19 CFR 113.73(b))). Furthermore, since the identity of the merchandise included in "losses" would have been lost, under 19 U.S.C. 81c(a), it could not be proportionately attributed to domestic and foreign merchandise; it would all have to be attributed to the foreign merchandise (if privileged and non- privileged foreign status merchandise could have been included in the "losses" according to the FTZ records, the losses would be attributed to the foreign status merchandise subject to the higher rate of duty (see 19 CFR 146.2(a)(3))).

In the proposed procedures, overages (described as "gains" in the proposal) would also be attributed to foreign and domestic status fuel on the basis of proportionate use and would be distributed to each airline on the basis of its percentage of total monthly consumption. Attribution of gains (or overages) to foreign and domestic status fuel is inconsistent with the above-described Customs Regulations; either all of the gains would have to be entered under a consumption entry or application for admission into the FTZ would have to be timely made under 19 CFR 146.53(d). Because it would have no potential effect on the revenue, we have no objection to attributing the gains to the airlines on the basis of their monthly consumption, assuming that there is a written agreement on the attribution of the gains so that right to make entry (see 19 CFR 141.11 et seq.) can be established. The airlines to which the "gains" were attributed would be required to make entry or application for admission into the FTZ, as stated above, and failure to timely do so would result in the fuel for which no such entry or application was made being sent to General Order.

HOLDINGS:

(1) Except in regard to the procedures for the physical inventory, reconciliation, shortages and overages (see below), the described FTZ accounting procedures described herein and in your submission meet current statutory and regulatory requirements (see C.S.D.'s 82-152 and 81-67).

(2) The proposed procedures for removal of the fuel from the FTZ (i.e., requiring the described records and accounting and, within 24 hours, the filing of a consumption entry and the deposit of duties for foreign fuel which, according to the Daily Inventory Records, would have to have been used on a non-qualifying (under 19 U.S.C. 1309) flight) are permitted under current law and regulations (as interpreted in the rulings cited in the LAW AND ANALYSIS portion of this ruling).

(3) The procedures for reconciliation of "book" and "physical" inventories in the described proposal, and for attributing "losses" and "gains" are not in accordance with current law and regulations. To comply with current regulations, the proposal would have to be modified as indicated in the LAW AND ANALYSIS portion of this ruling. I.e., gains and losses could not be attributed to foreign and domestic status fuel on the basis of proportionate use; instead all gains would have to be timely entered under a consumption entry or application for admission into the FTZ would have to be made and all losses would be subject to entry and the payment of duty, upon demand by Customs, as foreign merchandise of the status (privileged or non-privileged) subject to the higher rate of duty. Although gains could be attributed to airlines (which would be required to make the consumption entry or application for admission into the FTZ) on the basis of their monthly consumption, provided there was an appropriate written agreement establishing right to make entry, losses would have to be attributed to the FTZ operator which would be responsible, under its FTZ Operator's bond, for making entry for, and paying duties on the fuel, upon demand by Customs. (In addition, the requirements for promptly notifying Customs of any discrepancies and for the annual reconciliation report (see 19 CFR 146.23, 146.25, and 146.53) must be complied with.)

Sincerely,

John Durant, Director

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