HQ 224295

May 20, 1994

DRA-1-06/2-01-CO:R:C:E 224295 PH

CATEGORY: Drawback

Regional Commissioner of Customs

North Central Region

55 East Monroe Street

Chicago, Illinois 60603-5790

ATTN: Chief Region Drawback Branch

RE: Protest 3901-92-100583; Substitution Manufacturing Drawback;

Customs Audit; Random Sample; Statistical Analysis

Dear Sir:

The above-referenced protest was forwarded to this office

for further review. We have considered the points raised by your

office, the protestant, and the materials in the file. Our

decision follows.

FACTS:

The protest is of the liquidation of 57 drawback entries (or

claims) dated August 7, 1986, through October 26, 1989. The

protestant had received \$807,260 in accelerated payments of

drawback for the entries under protest. The entries were the

subject of a Customs audit (Report Control No. 321-89-DRO-006,

dated August 6, 1991). During the course of the audit, personnel

of the protestant met with Customs officials. The protestant

submitted amended entries (of the 57 drawback entries under

consideration) on May 15, 1990, August 27, 1990, and December 4,

1990\. The protestant conceded a number of errors in its original

entries and returned \$203,294 (received by Customs on October 1,

1990\) of the \$807,260 in accelerated payments.

Using established statistical analysis procedures, (i.e.,

establishing the applicable universe, determining the acceptable

rate of error, and using the appropriate tables for sampling size

and random selection of samples), a randomly selected sample of

the designated imported parts upon which drawback was claimed in

the 57 entries under consideration was selected. This sample

selection was applied to the second amendment (that submitted on

August 27, 1990) because, according to the audit report, the

sample had already been agreed upon when the third amendment was

filed. According to the Customs Regional office which performed

the audit, a list of the 291 parts selected to be sampled was

provided to the protestant and the protestant agreed and approved

the selected parts on November 20, 1990. The protestant also

states that it agreed to the sample (although after the

protestant reviewed the final results it contended that the

sample was distorted).

The above sampling procedures resulted in the audit of a

sample of 291 parts out of a universe of 6,580 parts in the

entries under consideration. Of the 291 parts sampled,

deficiencies were found with regard to 120 parts. The total duty

refunded as drawback for the 291 sampled parts was \$40,371

(\$138.732 per part). The total duty refund which the audit

report stated should have been disallowed was \$18,442 (\$63.375

per part). This disallowance per part was projected to the total

universe of parts, resulting in a calculation that \$412,837

should be disallowed (i.e., \$63.375 X 6,580 parts = \$417,007 X

99% = \$412,837).

The entries were liquidated in accordance with the above

advice between December 20, 1991, and February 7, 1992. The

liquidations of the entries were protested on March 17, 1992. In

addition to contending that the sample selected for audit

distorted the error rate for the entries, the protestant

specifically discussed certain items cited in the audit report.

These issues are analyzed in the LAW AND ANALYSIS portion of this

ruling.

ISSUE:

Is there authority to grant the protest of the denial of

drawback described in the FACTS portion of this ruling?

LAW AND ANALYSIS:

Initially, we note that the protest, with application for

further review, was timely filed under the statutory and

regulatory provisions for protests (see 19 U.S.C. 1514 and 19 CFR

Part 174). We note that the refusal to pay a claim for drawback

is a protestable issue (see 19 U.S.C. 1514(a)(6)).

The drawback entries which are protested are for drawback

under 19 U.S.C. 1313(b). Basically, section 1313(b), often

called the substitution manufacturing drawback law, provides that

if imported duty-paid merchandise and duty-free or domestic mer-

chandise of the same kind and quality are used in the manufacture

or production of articles within three years of the receipt of

the imported merchandise by the manufacturer or producer of the

articles and articles manufactured or produced from the imported

duty-paid merchandise or duty-free or domestic merchandise are

exported or destroyed within five years of the importation of the

duty-paid merchandise, 99 percent of the duties on the

imported duty-paid merchandise shall be refunded as drawback,

even if none of the imported merchandise was actually used in the

manufacture or production of the exported articles. The Customs

Regulations pertaining to drawback are found in 19 CFR Part 191.

The protestant claimed drawback under the general drawback rate

for articles manufactured with the use of component parts

(published in Treasury Decision (T.D.) 81-300).

The specific findings in the audit report addressed in the

protest are discussed below.

On page 7 \[page references are to the audit report\],

paragraph a) \[at top of page\], the report states that

quantities of the designated imports were greater than the

quantities actually imported. The protestant concedes this

error.

On page 7, paragraph b), the report states that a non-

existent consumption entry was used to designate imported

merchandise. The protestant appears to concede this error

(i.e., the error is addressed in the \"corrections\" section

of the protest and is stated to represent a misreading of

the consumption entry number). The protest is DENIED in

this regard.

On page 7, paragraph c), the report states that the duty

claimed per part was greater than the duty actually paid.

The protestant concedes this error.

On page 7, paragraph d), the report states that the imports

designated were duty-free merchandise, although drawback was

claimed. The protestant concedes this error.

On page 7, paragraph e), the report states that the

protestant was unable to relate Certificates of Delivery

against vendors\' invoices and inventory records. The

protestant attempts to explain this deficiency by stating

that import vendors supplied the protestant with

certificates of delivery showing delivered quantities which

often would not match quantities received by the protestant.

In this regard, we note that the Customs Regulations require

that a Certificate of Delivery in this situation \"must

describe the merchandise delivered, tracing it from the

custody of the importer to the custody of the manufacturer\"

(19 CFR 191.65(a)). The protest is DENIED in this regard.

On page 7, paragraph f), the report states that the

protestant did not provide records for a number of specified

reasons. The protestant contends that this statement is not

supported in the audit report by specific references and

should be ignored. The material which we have available to

us in the file does not indicate which parts sampled have

this deficiency. To the extent that drawback is denied on

this ground without reference to a specific sampled part and

specific records, the protest is GRANTED in this regard

(otherwise, the protestant is denied the right of protest

for that item). However, if drawback is denied on this

ground with regard to a specific sampled part and specific

records, the protest is DENIED in this regard for the

following reasons. The Customs Regulations (19 CFR 191.32,

191.2(o), 191.5, 191.10) require the keeping of certain

records for drawback and that the records be available for

examination by Customs. In its drawback contract, the

protestant agreed to maintain certain described records and

to make the records available for audit by Customs. The

protestant stated it understood that \"drawback is not

payable without proof of compliance\" and that \"if \[its\]

records do not show that \[it\] satisf\[ies\] those legal

requirements \[relating in part to record-keeping\], drawback

cannot be paid.\"

On page 7, paragraph a) \[bottom of page\], the report states

that certain designated imports were not used in production

and were in inventory. The protestant concedes that its

records did not correctly show the parts going into the

factory but states it could not build the articles without

this \"single-sourced\" part. Therefore, the protestant

contends, this error really had no effect on drawback. The

protestant also appears to contend that it could have

established compliance with this requirement (i.e., timely

use of the imported designated merchandise) by use of a

first-in, first-out (FIFO) accounting method. With regard

to the lack of proper records, see discussion of record-

keeping requirements, above. In the drawback contract

signed by the protestant, the protestant specifically agreed

to keep records to establish compliance with this

requirement. As to the protestant\'s arguments on the use of

the FIFO accounting method to establish the timely use of

the imported designated merchandise, it is true that \"if

FIFO accounting records are used and these records prove use

for drawback purposes, these records can be the basis for

allowance of drawback\" (C.S.D. 79-301). However, there is

no evidence in the file to show that the conditions

precedent for use of the FIFO accounting method in the above

quotation are met. The protest is DENIED in regard to this

issue.

On page 8, paragraph b) \[top of page\], the report states

that designated imported parts were identified on the

drawback claims as two different part numbers, although they

were one and the same part, resulting in the protestant

claiming drawback twice on the same designated imports. The

report refers to Exhibit 2 in this regard. The protestant

does not comment on this item. The parts referred to in

Exhibit 2 were not, themselves, part of the statistical

sample, although the Exhibit does illustrate unrebutted (by

the claimant) deficiencies in the claims. Because this

ruling is based on the sampled parts, the deficiencies shown

by Exhibit 2 do not affect the protest decision.

On page 8, paragraph c) \[top of page\], the report states

that designated imported parts were rejected as not meeting

the protestant\'s quality control standards. The protestant

states that it was having a problem with a supplier and

there was a lot of movement in and out of the factory with

this part. The protestant states that this \"single-sourced\"

part was necessary for the manufactured article and,

therefore, this error really had no effect on drawback. See

discussion of paragraph a), page 7 \[bottom of page\], in this

regard. The protest is DENIED, on the same basis, in regard

to this issue.

On page 8, paragraph d), the report states that the

protestant was unable to relate Certificates of Delivery

against vendors\' and certain worksheets and reports. See,

in this regard, discussion of paragraph e), page 7. The

protest is DENIED, on the same basis, in regard to this

issue.

On page 8, paragraph e), the report states that the

protestant did not provide records for a number of specified

reasons. See, in this regard, discussion of paragraph f),

page 7. On the same basis, to the extent that drawback is

denied on this ground without reference to a specific

sampled part and specific records, the protest is GRANTED in

this regard and, if drawback is denied on this ground with

regard to a specific sampled part and specific records, the

protest is DENIED in this regard.

On page 8, paragraph a), the report states that designated

imported parts claimed were never used to produce the

exported model (citing Exhibit 3). The protestant does not

directly address this item, but questions the apparent

indication by the report that designated imported parts must

be used to produce the exported model (in drawback under 19

U.S.C. 1313(b), of course, although the designated imported

merchandise and the substituted duty-free or domestic

merchandise must be used in a manufacture or production,

either or any combination of both may be used in the

manufacture or production of the exported article). We

conferred with the appropriate local Customs official in

this regard and found that the deficiency in this item is

that no part of the same kind and quality as the designated

imported part appeared in the exported article. We note

that each of the parts listed in Exhibit 3 is one of the

parts selected in the sample for audit. The protest is

DENIED in this regard.

On page 8, paragraph b) \[bottom of page\], the report states

that discontinued, obsolete and cancelled designated imports

were claimed to have been used to produce the exported

models (citing Exhibit 4). See, in this regard, discussion

of paragraph b, page 8 \[bottom of page\]. The protest is

DENIED, on the same basis, in regard to this issue.

On page 8, paragraph c) \[bottom of page\], the report states

that quantities of parts claimed on drawback entries

exceeded the \"bill of materials quantities\" (citing Exhibit

5; this exhibit clarifies this item, describing the

deficiency to be one in which the quantity of parts actually

appearing in the manufactured article, according to the bill

of materials, is less than the quantity of the same parts

claimed to appear in the manufactured article). The

protestant contends that this statement is not supported in

the audit report by specific references and should be

ignored. As explained above, this item does appear to be

supported in the audit report by specific references (see

Exhibit 5); clearly an overpayment of drawback results if

more parts are claimed for drawback than appear in the

manufactured article which is exported. Each of the parts

listed in Exhibit 5 appears to be one of the parts selected

in the sample for audit, with the possible exception of part

AT 38206. The protest is DENIED in this regard, except with

regard to part AT 38206 (if it is not one of the parts

selected in the sample for audit, in which case the protest

is GRANTED in this regard, for this part).

On page 9, paragraph a), the report states that quantities

of models claimed on the drawback entries to have been

exported exceeded the quantities of models actually shipped

and exported per the exportation records examined (citing

Exhibit 6). The protestant does not comment on this item.

A drawback claimant is specifically required to establish

exportation of articles for drawback purposes by the Customs

Regulations (19 CFR 191.51 et seq.) In the drawback

contract signed by the protestant, the protestant

specifically stated that it understood that \"it must be

established that the completed articles were exported within

5 years after the importation of the imported merchandise.\"

The protest is DENIED in this regard.

On page 9, paragraph b), the report states that exported

models on which drawback was claimed were shipped to Puerto

Rico and, therefore, drawback should not have been allowed

on those models. The protestant concedes this error.

On page 9, paragraph c), the report states that certain

exports were claimed, for drawback purposes, more than once

(citing Exhibits 6 and 7). The protestant does not comment

on this item. See discussion of paragraph a), page 9, in

this regard. The protest is DENIED in this regard.

On page 9, paragraph d), the report states that the

protestant was unable to provide exportation records on

shipments between November 1, 1983, and April 28, 1987. The

protestant contends that it could have provided records

(i.e., invoice records invoicing a foreign location and a

payment record for the same), but it was unable to provide

records in the format requested by Customs. The protestant

contends that such records should be satisfactory. As

stated in our comments on paragraph a), page 9, the Customs

Regulations have specific requirements for the establishment

of exportation for drawback purposes and the protestant

agreed to establish exportation in its drawback contract.

The cited Customs Regulations provide several alternative

kinds of evidence to establish exportation. Unless the

protestant meets one of these alternative requirements, the

protest is DENIED in this regard.

In addition to the specific items in the audit report

discussed above, the protestant comments on certain more general

items in the audit report (see pages 5 and 6 of the report).

These more general items do not appear to have had any effect on

the specific recommendations made in the audit report (i.e., the

conclusion of the audit report is that there should be a

disallowance of drawback for: (1) \"receipt and used-in production

of the designated imports\"; (2) \"used-in production of the

designated imports to produce the exports\" \[as noted in the

discussion of paragraph a), page 8, this deficiency is actually

that no part of the same kind and quality as the designated

imported part appeared in the exported article\]; and (3)

\"shipment of exports\"; and these three groups are dealt with in

the specific items discussed above). Therefore, we are not

commenting on the more general items, except insofar as our

comments on the specific items relate to them.

The protestant also contends that the statistical sample

used in this case highly distorted the error rate applied to the

drawback entries. In support of this contention, the protestant

notes that the average drawback claimed for the sampled parts was

\$138.73 although the average drawback claim for the universe of

6,590 parts was \$92.91. The protestant states that it understood

the purpose of the use of the statistical sample in this case to

be to determine a mean rate of error, with a maximum tolerable

rate of error of 10%. Noting that the difference in claimed

drawback in the sampled parts and in the entire universe is

\$45.82 per part, or 49.3%, the protestant contends that this

illustrates the distortion in the sample.

The Courts have approved the use of statistical analysis in

various situations (see, e.g., Castaneda v. Partida, 430 U.S.

482, 97 S.Ct. 1272 (1977), and cases cited therein; see also

Texpor Traders, Inc. v. Trust Co. Bank, 720 F. Supp. 1100 (S.D.

N.Y. 1989), in which the Court took judicial notice, \"that in

statistical analysis, using a well known mathematical theorem,

viz, the Central Limit Theorem, a sample size of thirty or more

is generally recognized as sufficient to guarantee normality of

the distribution of sample means\" (Note 2, 720 F. Supp. at 1105);

and Bright, Kadane, and Nagin, Statistical Sampling in Tax

Audits, 13 JOURNAL OF THE AMERICAN BAR FOUNDATION, Law & Social

Inquiry 305 (1988), see in particular pp. 310-318).

We also note that the Congressional Committees with

oversight of the drawback laws have recognized the validity of

the use of sampling as a drawback audit technique. Public Law

103-182, the \"North American Free Trade Agreement Implementation

Act\", has been enacted by both Houses of Congress and was signed

into law by the President on December 8, 1993. Section 632 of

Public Law 103-182 contains a number of amendments to the

drawback law (19 U.S.C. 1313). In the House and Senate reports

on H.R. 3450, the bill which was enacted as Public Law 103-182,

it was stated in regard to drawback that:

\... \[T\]he Committee expects that, if the entire universe of

the claimed import entries and exports is audited, and the

audit reveals that only a portion of a company\'s claims are

deficient, drawback should be denied only on that portion

found to be deficient. However, if only a representative

sample of the claimed import entries and exports is audited,

and the audit reveals that a significant portion of the

audited claims is deficient, then denial of the audited

company\'s drawback claims may extend beyond the portion

audited. \[H. Report 103-361, 103d Cong., 1st Sess., 132

(1993); see also, S. Report 103-189, 103d Cong., 1st Sess.,

84 (1993), which contains similar language.\]

In this case the sample was selected using established

statistical analysis procedures (the applicable universe was

established, an acceptable rate of error was determined, and the

appropriate tables for sampling size and random selection of

samples were used). After selection of the parts to be audited

in the sample, the protestant was given a list of the selected

parts and approved the sample selected. To this point in the

process, we see no inconsistency with the above authorities in

the sampling process.

However, according to both the protestant and the audit

report, \"a maximum tolerable rate of error of 10%\" was agreed

upon. According to the calculations in the audit report, the

rate of error was more than 67% (of the \$611,369 stated to be

included in the amended claim, \$412,832 was disallowed), far in

excess of the agreed upon maximum tolerable rate of error. (Even

with the correction to the calculations in the audit report

discussed below, the rate of error was much more than that which

was agreed to be acceptable.)

Upon finding an unacceptable rate of error, Customs should

have either given the claimant an opportunity to correct its

claims and re-audited the corrected claims with the use of an

agreed-upon sample or performed a 100% audit (i.e., without

recourse to statistical sampling) and liquidated the claims

accordingly. Instead, Customs proceeded to liquidate the claims,

projecting the rate of error it calculated from the audit to the

entire universe of drawback claimed in the entries.

Once liquidated, a liquidation may not be \"unliquidated\"

(see United States v. Utex International Inc., 6 Fed. Cir. (T)

166, 857 F. 2d 1408 (1988)). Absent probable cause to believe

there is fraud (see 19 U.S.C. 1521), the only action Customs is

authorized to take on a liquidation which has been timely

protested and for which the 90 days for voluntary reliquidation

have elapsed (see 19 U.S.C. 1501) is to allow or deny the protest

in whole or in part (see 19 U.S.C. 1515(a) (in this regard, see

also 19 U.S.C. 1515(c) and (d), as added to section 1515 by

section 617 of Public Law 103-182)).

Therefore, we must consider this protest as presented (i.e.,

even though Customs liquidated the entries on the basis of rates

of error which were agreed upon by Customs and the protestant to

be unacceptable). We conclude that the audit report erroneously

projected the audit findings to the universe of drawback claimed

in the entries. As stated above, 291 parts were sampled and 120

of those parts were found to have deficiencies. Thus, the simple

rate of error was 41.24%. The total drawback claimed for the 291

parts sampled was \$40,371 and the total drawback disallowed was

\$18,442. Thus, the rate of error based on drawback claimed for

the sampled parts was 45.68% As stated above, either of these

rates of error were agreed upon in advance to be unacceptable.

The audit report compounded the error of using an

unacceptable rate of error by its calculations to determine the

drawback which should be disallowed. This was done by using a

multiple-step process (which decreases the level of reliability)

in which the total drawback disallowed on the sampled parts

(\$18,442) was divided by the parts sampled (291) and the result

(\$63.375) was projected to the total parts in the universe. As

stated above, this results in an effective error rate of in

excess of 67% (of the \$611,369 stated to be included in the

amended claim, \$412,832 was disallowed). The fallacy in the

method used in the audit report is illustrated by projecting the

total drawback (allowed and disallowed) per sample audited to the

entire universe (i.e., \$138.55 X 6580 = \$948,999). This is

approximately 55% more than the actual entire universe (stated to

be \$611,369).

We understand that the purpose of the projection method used

in this case may have been to take into consideration the great

variances in drawback per part. Such a concern is proper, but

should be acted upon in the selection of the sample (e.g., by

stratified sampling) (see, generally, in this regard the article

by Bright, Kadane, and Nagin, cited above). As stated above,

attempting to redress this concern in the projection of the rate

of error, as was done in the audit report, decreases the level of

reliability of the sample. We conclude that in this case, in

which a simple random sampling method was used, the disallowance

of drawback from the sample audited should have been projected on

the basis of the simple rate of error (41.24%). The protest is

GRANTED, in part, in this regard.

According to the audit report, the amount of drawback

claimed on the amended entries (i.e., the August 27, 1990,

amendments) was \$611,369. The simple rate of error (41.24%)

should be projected to this figure, so that the total

disallowance of drawback is \$252,129. Each of the protested

drawback claims should be reliquidated using this simple rate of

error.

\[In its letter of September 20, 1993, in response to our

letter of July 13, 1993, requesting the protestant to provide

more information regarding this matter, the protestant again

suggested that the sample selection process used in this case was

flawed. The protestant alleges that the auditor knew that there

were deficiencies with certain parts and included those parts in

the sample, thus skewing the results. We disagree with this

allegation. According to the evidence available to us, the

sample was selected on a strictly random basis from the parts in

the claims then before Customs (and before the December 4, 1990,

amended claims were filed) and the protestant agreed to the parts

selected (also before the December 4, 1990, amended claims were

filed). Removing from the sample parts which, after the audit,

were found to have deficiencies negates the purpose of the

sampling process. Our decision in this matter is as stated

below.\]

HOLDING:

The disposition of the Protest of denial of drawback

described in this ruling is as follows:

The protest is DENIED, in part, and GRANTED, in part. The

entries should be reliquidated in accordance with this decision.

In accordance with Section 3A(11)(b) of Customs Directive 099

3550-065, dated August 4, 1993, Subject: Revised Protest

Directive, this decision should be mailed by your office, with

the Customs Form 19, to the protestant no later than 60 days from

the date of this letter. Any reliquidation of the entry in

accordance with the decision must be accomplished prior to

mailing of the decision. Sixty days from the date of the

decision 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