HQ H021426

April 2, 2008

**OT:RR:CTF:VS** H021426 JPP

**CATEGORY**: Valuation

Ms. Sandra Liss Friedman

Barnes, Richardson & Colburn

475 Park Avenue South

New York, New York 10016

**RE**: Treatment of Administrative Costs in Determining the Regional
Value Content ("RVC") of Pumps and Motors Assembled in Mexico Under the
North American Free Trade Agreement ("NAFTA")

Dear Ms. Friedman:

This is in response to your letter dated December 13, 2007, on behalf of
ITT Corporation ("ITT") of White Plains, New York, in which you
requested an advance ruling under the Appendix to Part 181, Customs
Regulations (19 C.F.R. Part 181, App.; NAFTA Rules of Origin Regulations
("Rules of Origin")), regarding the treatment of certain administrative
costs in determining the regional value content ("RVC") of a good under
the North American Free Trade Agreement ("NAFTA").

**FACTS:**

The merchandise at issue consists of finished pumps and motors that ITT,
through its business unit Flojet ("ITT Flojet"), imports from Mexico.
The pumps and motors are manufactured by an unrelated Mexican company,
Grupo American Industries, S.A. de C.V. ("American Industries"), which
provides ITT with contract assembly services under what is commonly
referred to as "maquiladora shelter operation." American Industries'
assembly operations devoted to the production of Flojet pumps and motors
are located in Chihuahua, Mexico ("AI FJ"). You have advised that the
imported pumps are classified under subheading 8413.50 of the Harmonized
Tariff Schedule of the United States ("HTSUS"); and the motors are
classified under subheading 8501.31, HTSUS.

Under the instant manufacturing arrangement, ITT Flojet retains
ownership of materials, components, tools and machinery used in the
production of the pumps and motors. The cost of these items is recorded
on ITT Flojet's books. American Industries maintains a separate office
in Chihuahua, Mexico that provides administrative support to all its
production facilities, including AI FJ's. In preparing an individual
operation's financial and accounting records, American Industries
determines the cost of the administrative support services attributed to
each operation and records the expenses assigned to the individual
operation on its books and records. Ultimately, these expenses are
allocated to each manufacturing operation.

Production, overhead and labor costs associated with ITT Flojet
products, including direct and indirect labor, direct and indirect
factory overhead and operating costs, transportation, brokerage, duties
and taxes, and general and administrative ("G&A") expenses, are recorded
on American Industries' books. Included in the G&A expenses allocated by
American Industries to the AI FJ assembly operations are costs which,
while not directly production related, are incurred because of the
contractual obligations undertaken by American Industries to effectuate
the production of the subject merchandise. These expenses are more fully
described as follows:

(a) Administrative Labor

> This account includes the office staff and management payroll costs of
> the American Industries administrative support office attributable to
> the AI FJ production facility.

(b) Global Labor (Admin.)

> This account includes the global labor benefits related to AI FJ's
> Administrative Labor. The global labor benefits includes the company's
> contribution to social security insurance, medical plan insurance,
> payroll taxes, employee housing program, and employee saving funds.

(c) Shelter Fee

> This account includes other G&A costs related to the operation and
> production activities of AI FJ and American Industries' profit on its
> services to ITT Flojet. Specifically, the G&A costs include: human
> resource services, accounting and fiscal services, customs services,
> freight forwarding, environmental control, purchase of non-production
> goods and services and expatriate assistance.

In determining the NAFTA eligibility of the motors and pumps, American
Industries and ITT Flojet propose to use the net cost method of
calculating RVC.

Counsel submits that the above-referenced administrative expenses are
recorded on American Industries' books and incurred solely to support AI
FJ maquiladora shelter operations and enable the goods to be delivered
to the United States. Counsel requests confirmation that these costs,
with the exception of the profit factor included in the Shelter
Fee,[^1]^/^ can be included in the calculation of "total costs" for
purposes of determining RVC.

No cost information was furnished in connection with this ruling
request. Therefore, the scope of this ruling is limited to the treatment
of the specific expenses described above in determining RVC and does not
address the NAFTA eligibility of the imported merchandise.

**ISSUE:**

Whether certain administrative expenses, which are recorded on American
Industries' books, may be included in the calculation of RVC for
purposes of NAFTA eligibility.

**LAW AND ANALYSIS:**

Under Section 4 of the NAFTA Rules of Origin Regulations (19 C.F.R.,
Part 181, App., Sec. 4), a good originates in the territory of a NAFTA
Party if it is "wholly obtained or produced" in accordance with Sec.
4(1), or if it satisfies the applicable change in tariff classification,
the applicable RVC requirement or combination thereof under Sec. 4(2).

The appropriate change-in-tariff and RVC requirements for particular
tariff headings are described in General Note ("GN") 12, HTSUS. The
NAFTA Rule of Origin for each of the goods at issue, *i.e.*, motors and
pumps, provides that the good will be considered to originate for NAFTA
purposes if it satisfies: (a) a change in tariff classification; or (b)
meets an alternative change in classification requirement and satisfies
a RVC test. *See* GN 12(t)/84.25 and GN 12(t)/85.1, HTSUS. You have
requested Customs and Border Protection ("CBP") to use the second
alternative rule of origin for each of these goods, *i.e.*, the net cost
method.

[Regional Value Content Calculation]{.underline}

General Note 12(c), HTSUS, provides the methods for determining the RVC
of a good for purposes of NAFTA. The net cost method is set forth in GN
12(c)(ii), HTSUS, and provides as follows:

> The regional value content of a good may be calculated on the basis of
> the following net cost method:
>
> RVC = (NC - VNM) / NC x 100
>
> Where RVC is the regional value content, expressed as a percentage; NC
> is the net cost of the good; and VNM is the value of the
> non-originating materials used by the producer in the production of
> the good. *See also*, Sec. 6(3), Rules of Origin.

The methods of calculating the net cost of a good are set forth in Sec.
6(11), Rules of Origin. Subsection (11) provides three methods from
which the producer of a good may choose to calculate the net cost, all
of which involve the calculation of the producer\'s total cost. The
methods are:

> \(a\) calculating the total cost incurred with respect to all goods
> produced by that producer, subtracting any excluded costs that are
> included in that total cost, and reasonably allocating, in accordance
> with Schedule VII, the remainder to the goods;
>
> \(b\) calculating the total cost incurred with respect to all goods
> produced by that producer, reasonably allocating, in accordance with
> Schedule VII, that total cost to the good, and subtracting any
> excluded costs that are included in the amount allocated to that good;
> or
>
> \(c\) reasonably allocating, in accordance with Schedule VII, each
> cost that forms part of the total cost incurred with respect to the
> good so that the aggregate of those costs does not include any
> excluded costs.
>
> Section 6(11), Rules of Origin.

Under the three methods set forth in Sec. 6(11), certain "excluded
costs" need to be deducted from total cost in determining net cost.
"Excluded costs" consist of "sales promotion, marketing and after-sales
service costs, royalties, shipping and packing costs and non-allowable
interest costs." Sec. 2(1), Rules of Origin. Each of these aspects of
"excluded costs" are further defined in section 2(1) of the Rules of
Origin.[^2]^/^

Furthermore, in calculating net cost, any costs that are a part of total
cost and need to be allocated to the goods must be allocated in
accordance with Schedule VII (Reasonable Allocation of Costs), Rules of
Origin.

[Calculation of Total Cost]{.underline}

The calculation of net cost initially requires the proper calculation of
the "total cost." Section 6(12) provides that "total cost" is calculated
in accordance with Sec. 2(6) of the Rules of Origin which state that
"total cost" consists of all product costs, period costs and other costs
that are recorded, except as otherwise provided (*e.g.*, in the case of
materials and intermediate materials) on the books of the producer. Sec.
2(6), Rules of Origin. The term "product costs" is defined as "costs
that are associated with the production of a good, and includes the
value of materials, direct labor costs and direct overhead"; the term
"period costs" is defined as "costs, other than product costs, that are
expensed in the period in which they are incurred." *Ibid.,* Sec. 2(1).
"Other costs," with respect to total cost, are defined as "all costs
that are not product costs or period costs." *Id*.

Total cost, therefore, is determined on the basis of the expenses
recorded on the *books of the producer*, except in the case of materials
and intermediate materials, whose value is determined, respectively, in
accordance with other sections in the Rules of Origin. For NAFTA
purposes, the term \"producer\" is defined as "a person who grows,
mines, harvests, fishes, traps, hunts, manufactures, processes or
assembles a good." Sec. 2(1), Rules of Origin. Based on this definition
and the information provided in the Facts section above, we determine
that American Industries is the producer of the subject merchandise
within the definition of Sec. 2(1).

In prior rulings, CBP has considered the treatment of producer's costs
in the calculation of RVC under the NAFTA. In Headquarters Ruling Letter
("HRL") 545675, dated April 28, 1995, CBP considered the treatment of
indirect labor costs, factory overhead and operating costs in the
calculation of RVC under the net cost method. CBP concluded that those
costs could be included as part of the net cost of the imported
electronic products, provided that they were recorded on the books of
the producer. *See also* HRL 545635, dated November 29, 1994 (finding
that because the expenses were not recorded on the producer's books as
required by the Rules of Origin, they could not be included in the
calculation of the producer's total cost); and HRL 547881, dated August
27, 2001 (finding that only the product costs, period costs and other
costs recorded on the Mexican producer's books may be included in the
calculation of total cost).

Clearly, HRLs 545675, 545635 and 547881 emphasized that only the costs
on the books of the producer (*i.e.,* recorded on the Mexican accounting
books) are to be considered in determining net cost.

Consistent with the net cost RVC provisions in the Rules of Origin and
prior rulings, we determine that the administrative expenses
(Administrative Labor, Global Labor, Shelter Fee Costs) which are used
to support the AI FJ maquiladora shelter operation and are recorded on
American Industries' books, *may* be included in the calculation of
producer's total cost for purposes of determining RVC, except for the
expenses related to (a) employee saving funds, (b) expatriate assistance
and (c) non-production goods and services. Potentially includable costs
must be allocated to the products produced for ITT Flojet (and
segregated from costs related to products produced for other clients) in
accordance with the reasonable allocation provisions of Schedule VII,
Rules of Origin. All excluded costs, as specified in Sec. 2(1), must be
deducted from total cost in order to arrive at the net cost of the
imported ITT Flojet product(s).

Based on the description of the costs at issue, we are of the opinion
the following expenses are likely *not* to qualify as includable costs
in the calculation of RVC:

> \(a\) Employee service funds.- Employee service funds are often
> financed from company profit and thus may be treated as profit
> sharing, *e.i.*, monies paid out to other persons as dividends.
> Assuming this to be the case, and depending on the basis of profit,
> these costs would be treated as excluded costs for purposes of
> determining RVC. *See* Sec. 2(6), Rules of Origin.
>
> \(b\) Expatriate assistance.- Expatriate assistance is generally
> incurred to support foreign labor relocation (including relocation of
> employees' families), is often general in scope and too far removed
> from product "manufacturing" or "production" to be construed as a part
> of the net cost of a finished product. Expatriate assistance costs are
> also sometimes reimbursable and, as such, would not be treated as an
> actual or real cost to the producer.
>
> \(c\) Non-production goods and services.- Costs for non-production
> goods and services are often incurred for sales promotion, marketing
> or after-sales services. Assuming this to be the case, these expenses
> would be considered non-includable costs in determining RVC. Otherwise
> these costs may qualify as includable, provided that all other
> applicable net cost RVC provisions in the Rules of Origin are met.

We note that post-production costs (*e.g.*, costs incurred for customs
services related to exportation; post-production human resource services
or post-production environmental control) would not be treated as
includable in the calculation of RVC. However, pre- and current
production costs (*e.g.,* customs or freight forwarding services related
to the importation of raw materials and other inputs) could qualify as
includable costs, provided that all other applicable net cost RVC
provisions in the Rules of Origin are met.

Also, please note that the actual determination as to the inclusion of
the costs at issue in determining RVC will be made by the appraising
officer at the applicable port of entry and will be based on the
documentation submitted.[^3]^/^

**HOLDING:**

Based on the information provided, the Administrative Labor, Global
Labor and Shelter Fee (minus profit) costs recorded on American
Industries' books *may* be included in the calculation of total cost for
purposes of determining RVC, provided that the costs can be reasonably
allocated, in accordance with Schedule VII, to the goods at issue.
Excluded costs, as specified in Sec. 2(1) in the Rules of Origin, must
be deducted from total cost in order to determine the net cost of the
specific goods. Costs incurred by the producer in connection with
employee saving funds, expatriate assistance, purchase of non-production
goods and services, and post-production expenses are likely to be
treated as non-includable costs in the calculation of RVC for the
reasons stated above.

A copy of this ruling letter should be attached to the entry documents
filed at the time this merchandise is entered. If the documents have
been filed without a copy, this ruling should be brought to the
attention of the CBP officer handling the transaction.

> Sincerely,
>
> Monika R. Brenner, Chief
>
> Valuation and Special Programs Branch

[^1]: ^/^ Counsel concedes that "total cost" does not include profits
    that are earned by the producer, as provided in Sec. 2(6) of the
    NAFTA Rules of Origin Regulations.

[^2]: ^/^ For example, Sec. 2(1) defines the phrase "sales promotion,
    marketing and after-sales service costs" to include excluded costs,
    such as:

    salaries and wages, sales commissions, bonuses, benefits (for
    example, medical, insurance, pension), traveling and living
    expenses, membership and professional fees, for sales promotion,
    marketing and after-sales service personnel;

    > \(d\) recruiting and training of sales promotion, marketing and
    > after-sales service personnel, and after-sales training of
    > customers' employees, where such costs are identified separately
    > for sales promotion, marketing and after-sales service of goods on
    > the financial statements or cost accounts of the producer; . . .

    Sec. 2(1), Rules of Origin.

[^3]: ^/^ For NAFTA eligibility purposes, RVC calculations must be made
    in accordance with Generally Accepted Accounting Principles ("GAAP")
    and supported by producer's internal records, taking into account
    all relevant costs (including product costs, period costs and other
    costs).