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HQ 545384

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November 23, 1993

VAL CO:R:C:V 545384 GG

CATEGORY: VALUATION

Mr. Peter Battaglioli
Regional Director, Regulatory Audit Division Northeast Region
U.S. Customs Service
10 Causeway Street, Suite 603
Boston, MA 02222-1059

RE: Request for Internal Advice; computed value

Dear Mr. Battaglioli:

This is in response to the request for internal advice forwarded by you on behalf of Matol Botanical International, Ltd. ("MBI").

FACTS:

MBI is a Canadian producer of nutritional and dietary products, food supplements, and cosmetics, which it sells in Canada, the United States, and other world markets.

Customs conducted an audit of MBI, focusing on imports of a mineral food supplement known as "Km". Movements of Km from Canada to the United States do not involve sales, but rather consignments of inventory to storage warehouses in the United States. These warehouses are operated by a U.S. company related to MBI.

Small independent distributors in the United States purchase Km from MBI's Canadian office by phone and then resell the product to their customers. Km shipments are then made from the existing inventory stock stored in the U.S. warehouses. Several times a day, the sales orders placed in Canada are batched by computer with appropriate shipping instructions and are sent electronically to computer terminals located in the U.S. warehouses.

Customs and MBI agree that computed value is the proper appraisement method. The issues that prompted MBI to seek internal advice concern various adjustments that the company made to its costs to arrive at a computed value of $8.62 (Canadian) per bottle of Km. Your office disputes the accuracy of some of these adjustments.

Specifically, the adjustments involve: the reclassification of certain manufacturing costs from the cost of goods sold to general expenses; the exclusion of sales commissions, conventions and seminars, credit card fees, management fees, depreciation, and unused floor space from general expenses; and the inclusion of an unusual and non-recurring expense in the calculation of profit. We will address each of these issues in turn.

ISSUE:

1) Whether certain costs recorded in MBI's financial statement as cost of goods sold are fabrication costs or general expenses for computed value purposes?

2) Whether various costs incurred in the United States but recorded on the producer's books as a general expense are included in computed value?

3) Whether an unusual and non-recurring expense should be included in the calculation of profit for computed value purposes?

LAW AND ANALYSIS:

Section 402(e) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. 1401) provides that computed value consists of the sum of:

(A) the cost or value of the materials and the fabrication and other processing of any kind employed in the production of the imported merchandise;

(B) an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind as the imported merchandise that are made by the producers in the country of exportation for export to the United States;

(C) any assist, if its value is not included under subparagraph (A) or (B); and

(D) the packing costs.

Issue 1.

In its internal advice request, MBI questions the auditors' taking exception to its classification of certain costs as general expenses on its computed value statement. These costs, incurred at MBI's manufacturing plant in Canada, were for rent, utilities, telephone, depreciation, maintenance and repairs, fire and liability insurance, equipment rental, office supplies and postage, recruitment fees, and other general administrative expenses. The disagreement arose because MBI reported these costs as part of cost of sales in its financial statements. In the auditors' view, overhead costs - such as rent, utilities, telephone, depreciation, maintenance and repairs, insurance and equipment rental - that are listed as a cost of sales in a company's financial statements are fabrication costs rather than general expenses. Of course, office supplies and postage, recruitment fees, and other general administrative expenses will still be considered to be general expenses.

MBI argues that under Canadian GAAP the reclassified expenses could have been reported as either cost of goods sold or general expenses in the financial statement. The decision to report the expenses under cost of sales was, according to MBI, nothing other than an exercise of management prerogative, which GAAP allows. MBI claims that the nature of the costs did not change by reason of this decision. They remained general administrative expenses, albeit incurred at the factory instead of the company's headquarters. By classifying the costs as general expenses on the computed value statement, MBI contends that it was merely abiding by the requirements of the statute, which refers to general expenses rather than to cost of goods sold.

It appears that the only issue presented is whether these particular costs that were reported on MBI's financial statements as part of the cost of sales were fabrication costs or general expenses. Essentially, it is an accounting question. Your office has advised us that from an audit perspective the overhead costs are costs of fabrication. You agree that the cost of office supplies, postage, recruitment fees, and general administrative expenses is properly classified as a general expense. Consequently, there is no legal issue for this office to decide, and these costs will be treated as fabrication costs or general expenses in accordance with your advice.

Issue 2.

Certain general expenses related to MBI's U.S. operations were recorded on MBI's books and records but were excluded from the company's calculation of its computed value. These expenses include commissions paid to distributors on U.S. sales, the costs of conventions and seminars conducted in the U.S., and commissions paid to marketing companies on U.S. sales made in the years in which the marketing companies appeared and participated at the various meetings, conventions, and seminars. In addition, credit card fees on U.S. sales, management fees to operate U.S. warehouses, and depreciation expenses associated with MBI assets used in the U.S. warehouses have all been excluded from the computed value computation.

MBI argues that these expenses were incurred after the Km was manufactured and packed ready for shipment to the United States, and that therefore they were no longer dutiable costs. The company primarily relies on court decisions rendered under the constructed value method of valuation, in effect prior to the enactment of the TAA in 1979. The auditors counter that the types of expenses involved are allocable to Km and are actual selling expenses that are booked on the commercial accounts of MBI in accordance with Canadian GAAP. As such, in their opinion, they should be dutiable.

The Statement of Administrative Action, which was adopted by Congress, provides that

[t]he amount for profit and general expenses will be determined on the basis of information supplied by, or on behalf of, the producer and will be based on the commercial accounts of the producer, provided that such accounts are consistent with the generally accepted accounting principles applied in the country where the goods are produced and unless the figures provided are inconsistent with those usually reflected in sales of merchandise of the same class or kind as the imported merchandise, that are made by the producers in the country of exportation for export to the United States.

Senate Report 96-249 to Public Law 96-39 adds that "determination of an acceptable computed value generally would require the producer to supply all the necessary cost information . . .[t]he bill also would provide for the use of the producer's own general expenses and profit unless such amount is inconsistent etc. . ." Thus, the legislative history of the TAA stresses reliance on the producer's books to obtain figures from which a computed value can be calculated.

It is uncontested that MBI's accounts are in accordance with Canadian GAAP. Furthermore, no evidence has been submitted to demonstrate that the expenses at issue are inconsistent with the expenses that are usually reflected in sales of merchandise of the same class or kind as the imported merchandise. Accordingly, the amount for profit and general expenses to be included in computed value will be the amounts contained in MBI's commercial accounts. In this case, the expenses related to MBI's U.S. operations are carried on MBI's books as general expenses therefore are properly a component of computed value under Section 402(e)(B) of the TAA.

Issue 3.

In fiscal year 1990, MBI determined that certain receivables for a related Malaysian company were uncollectible. As a result, the company was required under accounting rules in Canada to disclose the write-off in its year-end financial statement. In calculating a profit for purposes of the computed value statement, MBI adjusted its reported income from operations to account for the write-off before allocating net income to its various business activities.

MBI argues that the write-off was an unusual item, which under GAAP had to be taken into account in determining net income from operations. The auditors agree that the write-off was an unusual item, and that unusual items are required to be separately identified and presented on the company's financial statement to arrive at profit before taxes. However, they do not agree that the write-off should be used to reduce the amount of profit allocated to Km imported into the United States.

By way of explanation, you state that the objective of product costing is to identify all direct costs of a product (specific identification) and to allocate the remaining indirect costs that benefit the product on an equitable basis. The write-off, in the auditors' opinion, is neither a direct cost nor an allocable indirect cost which benefits the imported Km. Therefore, the Malaysian bad debt write-off bears no relationship to the cost or profit which should be assigned to the Km that is imported into the United States.

As mentioned earlier, the amount for profit and general expenses under Section 402(e)(B) of the TAA is based on the producer's profit and general expenses, unless the producer's profit and general expenses are inconsistent with those usually reflected in sales of merchandise of the same class or kind as the imported merchandise. In HRL 544616, dated April 15, 1991, it was determined that severance payments made to discharged employees should be included in the computed value of the imported merchandise as part of the general expenses and profit. The payments were dutiable because they were made as a direct consequence of termination of employment and therefore were within the category of general expenses usually reflected in sales of merchandise of the same class or kind. In MBI's situation, a write-off for losses incurred in Malaysia would lead to an inconsistent figure for profit and general expenses.

In HRL 543276, dated May 15, 1984, we held that currency conversion losses cannot be used for computed value purposes because the losses had no direct relationship to the assembly process and were used only to balance the general ledger when accounts were converted from foreign currency to U.S. dollars. In our view, MBI's Malaysian losses were not connected in any way to the assembly process of Km, and therefore cannot be used to calculate profit and general expenses for computed value purposes.

HOLDING:

1) The overhead costs recorded on MBI's financial statement as cost of goods sold are fabrication costs and are part of computed value under Section 402(e)(A) of the TAA. The costs incurred for office supplies, postage, recruitment fees, and other general administrative expenses are general expenses and will be included in the amount for profit and general expenses pursuant to Section 402(e)(B) of the TAA.

2) Various costs incurred in the United States that were recorded on MBI's books as general expenses are included in computed value under Section 402(e)(B) of the TAA.

3) An unusual and non-recurring expense for losses suffered by MBI in Malaysia may not be used to calculate the amount of profit and general expenses for computed value purposes.

This decision should be mailed by your office to the internal advice requester no later than 60 days from the date of this letter. On that date the Office of Regulations and Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Lexis, Freedom of Information Act and other public access channels.

Sincerely,

John Durant
Director, Commercial
Rulings Division

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