HQ 544067

June 12, 1989

CLA-2 CO:R:C:V 544067 BJO

CATEGORY: Classification

Mr. Jeffrey G. Wood

GTE Sylvania Special Products, Inc.

P.O. Box 780

Luquillo, Puerto Rico 00673

RE: Entry of Network Interface Device Subassemblies under the

Caribbean Basin Initiative

Dear Mr. Wood:

This is in response to your letters of September 10, 1987

and December 16, 1988, concerning a ruling that Haitian-assembled

Network Interface Device subassemblies qualify for duty-free

entry under the Caribbean Basin Economic Recovery Act (CBERA)(19

U.S.C. 2701-2706). We regret the delay in responding to your

request.

FACTS:

You state that each subassembly is made in Haiti, and

includes 38 component parts of Puerto Rican and U.S. origin.

Upon completion, the subassemblies are shipped directly to the

U.S., where they are used in the manufacture of telephone network

interface devices. You further state that the value of the U.S.

components used in the production of each subassembly exceeds 15%

of the appraised value of each article, and that the value of the

components manufactured in Puerto Rico exceeds an additional 15%

of each article\'s value.

The major features of the Haitian assembly process, which

you state involve 19 different operations and 50 individual

procedures, are as follows:

1\. Ring terminals and gold wire splices are crimped with a

crimping machine to opposite ends of each of four pre-cut

insulated wires, which are then inserted by hand and staked

with a seat lead fixture through a prefabricated base. On

the reverse side of the base, the gold wires protruding from

the staked wires are plunged with a contact wire fixture

into a cavity in the base, forming contact wires.

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2\. The staked wires are bent to the side of the base with a

hand tool, and, with an ultrasonic welder, the wires are

capped at the base with a plastic piece. Each wire is then

tested with a jack short tester for continuity.

3\. The jacket of a separate cable is trimmed by hand with an

X-acto knife and the cable is inserted through a pre-cut

hole in the base. A plug is attached to the trimmed end of

this cable by means of a crimping fixture and pliers. The

other end of the cable is trimmed and a square terminal is

crimped to each of the 4 insulated wires contained within

the cable jacket. Epoxy encapsulant is injected into both

sides of the plug lead-in and to the cavity of the base

where the cable had been inserted, and the entire base

assembly is baked for one hour to solidify the epoxy.

4\. A four-color adhesive strip is applied to the base. The

four square terminals are pulled through the base and

attached with screws according to the color strip to four

pre-cut holes in the reverse side of the base.

5\. A pre-cut \"pigtail\" cable containing four insulated wires

is crimped at one end with four spade terminals, and each of

these 4 terminals, as well as the four ring terminals

described in the first step, are attached by power

screwdriver to 4 pre-cut points on the base. A gasket is

then applied to the face of the plug described in step 3

above, and the base assembly is tested for short and open

circuits.

6\. Three-eighths of one inch of the insulation of three of

the four wires contained in the pigtail is hand stripped, a

resistance test is performed on the pigtail wires, excess

epoxy is removed with the X-acto knife, a UL sticker is

added, a retaining screw is inserted into a pre-cut hole in

the base, a retainer is attached, quality control performed,

and the assembly is packed for shipment.

You advise that the direct cost of the above described

processing operations is equivalent to 18.4% of the subassembly\'s

total value, if the following cost components are included within

the direct cost computation:

1\. Direct labor and associated fringe benefits.

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2\. Indirect labor, including material handlers, group

leaders, and quality control inspectors, and associated

fringe benefits.

3\. Electricity used for manufacturing equipment.

4\. Haitian inland freight and brokers fees associated with

the raw materials used.

5\. Manufacturing foreman and associated fringe benefits.

6\. Equipment maintenance personnel and associated fringe

benefits.

7\. Quality Control supervisor and associated fringe

benefits.

8\. Cost of transportation provided to direct labor

employees.

9\. Depreciation on machinery and equipment.

You state that the following costs have not been included as

direct processing costs:

10\. Profit

11\. Telephone and telex expenses.

12\. Office supplies.

13\. Facility maintenance expenses.

14\. Electricity consumed for lighting and office air

conditioning.

15\. Auto and truck expenses.

16\. Plant manager and associated fringe benefits.

17\. Facility maintenance personnel and associated fringe

benefits.

18\. Accounting personnel and associated fringe benefits.

19\. Industrial engineer and associated fringe benefits.

20\. Shipping and receiving personnel and associated fringe

benefits.

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21\. Taxes and insurance expenses.

22\. Plant security.

23\. Other miscellaneous expenses.

Finally, your letter states that the subassemblies have been

manufactured at your company\'s facility in Haiti, which has a

labor force of nearly 800, and have been entered under item

685.90, Tariff Schedules of the United States.

ISSUE:

I. Whether the subassemblies assembled in Haiti from

components manufactured in Puerto Rico and the U.S. are products

of Haiti for purposes of the CBERA.

II\. Whether the costs involved in assembling the

subassemblies in Haiti are direct costs of processing operations

for CBERA purposes.

LAW AND ANALYSIS:

Under the CBERA, eligible articles the growth, product, or

manufacture of a beneficiary country (\"BC\") which are imported

directly to the U.S. from a BC qualify for duty-free treatment,

provided the sum of (1) the cost or value of materials produced

in a BC or two or more BC\'s, plus (2) the direct costs of

processing operations performed in a BC or countries is not less

than 35% of the appraised value of the article at the time it is

entered. See 19 U.S.C. 2703(a)(1).

Haiti is a BC under CBERA, and the imported subassembly is

CBERA-eligible. Your letter indicates that the articles are

imported directly to the U.S. Accordingly, the articles may be

entered duty-free under CBERA if they are products of Haiti, and

if the 35% value-content requirement is met.

I. \"Product of\" Requirement

An article assembled in a BC from materials originating from

outside the BC, as here, is the \"growth, product, or manufacture\"

of the BC if the non-BC materials are substantially transformed

in the BC into a \"new and different article of commerce.\" See 19

CFR 10.195(a)(1).

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We find that the Haitian assembly operation substantially

transforms the materials imported into Haiti into a new and

different article of commerce. A substantial transformation

occurs \"when an article emerges from a manufacturing process with

a name, character, or use which differs from those of the

original material subjected to the process.\" See The Torrington

Co. v. United States, 764 F.2d 1563, 1568 (Fed. Cir. 1985). In

determining whether the combining of parts or materials

constitutes a substantial transformation, the issue is the extent

of operations performed and whether the parts lose their identity

and become an integral part of a new article. Belcrest Linens v.

United States, 741 F.2d 1368, 1373 (Fed. Cir. 1984) If the

combining process is merely a minor one which leaves the identity

of the imported article intact, a substantial transformation has

not occurred. Uniroyal, Inc. v. United States, 542 F.Supp.1026,

1029 (CIT 1982), aff\'d, 702 F.2d 1022 (Fed. Cir. 1983); see also

19 C.F.R. 10.195 (\"No article or material shall be considered to

have been grown, produced, or manufactured in a beneficairy

country by virtue of having undergone simple (as opposed to

complex or meaningful) combining or packaging operations.\").

In C.S.D. 85-25, we found that an assembly operation was

\"complex and meaningful\" in view of:

\"a very large number of components, a significant number of

different operations, \[which\] required a relatively

significant period of time, as well as skill, attention to

detail and quality control, and\...significant economic

benefit to the BC from the standpoint of both value added to

each article, and the overall employment generated thereby.\"

The assembly process described in your letter also involves

a significant number of components and assembly procedures, and

requires use or operation of a number of different tools and

pieces of equipment, and consequent skill and attention to

detail. In addition, the resultant economic benefit to Haiti

appears significant in light of your statement that the Haitian

production facility employs 800 workers, and the per item direct

cost of the processing is equivalent to 18.4% of the total value

of the article.

As a result of the Haitian assembly operation, the

subassembly is a new article which has a distinct electronic

function apart from its component parts, and is ready for

incorporation into a telephone network interface device when

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completed. Further, the component materials, such as the

insulated wires, cable, plug, terminals, and bare base assembly,

lose their own identity and become integral parts of the

subassembly. In The Diamond Match Company v. United States, 49

CCPA 52 (1961), the court found that wooden sticks, which had

been inserted into ice cream and frozen to form \"ice-cream-on-a-

stick,\" lost their identity and became integral parts of the new

article because the new article could not function without them,

and the sticks could not be removed without destroying the

product. In a similar manner, subassembly here will not function

without the component parts, and the component parts are

physically altered and permanently affixed in the new article.

For these reasons, we find that the subassemblies are products of

Haiti for purposes of CBERA.

II\. The 35% Value-Content Requirement

The CBERA provides that the cost or value of materials

incorporated in the final article which are produced in the

customs territory of the U.S., excluding Puerto Rico, may be

included in the 35% value-content calculation, but in an amount

not to exceed 15% of the appraised value of the article at the

time it is entered. See 19 U.S.C. 2703(a)(1). The cost of

materials produced in Puerto Rico may be applied to satisfy the

35% value-content requirement without limitation. Id. You may

therefore apply all costs of materials which are produced in

Puerto Rico and incorporated in the subassemblies toward the 35%

value-content minimum; the 15% cap applies only to costs of

materials produced in the customs territory of the U.S. other

than Puerto Rico.

\"Direct costs of processing operations\" are those costs

which are either directly incurred in, or which can be reasonably

allocated to, the growth, production, manufacture, or assembly of

the specific merchandise under consideration. See 19 CFR

10.197(a). They include \"all actual labor costs involved in the

growth, production, manufacture, or assembly of the specific

merchandise, including fringe benefits, on the job training, and

the cost of engineering, supervisory, quality control, and

similar personnel.\" See 19 CFR 10.197(a)(1). Profit and general

expenses of doing business, such as administrative salaries and

casualty and liability insurance are not direct costs of the

processing operation. See 19 CFR 10.197(b).

The salaries, wages, and fringe benefits of those workers,

including quality control inspectors, who are directly engaged in

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the production of the subassemblies may be included in the 35%

value-content requirement as a direct cost of the processing

operation. See C.S.D. 80-246, dated April 23, 1980 (HQ

542097)(Salaries, wages, fringe benefits of production workers

are direct costs for purposes of the GSP).

The costs of transportation provided to direct labor

employees is a direct processing cost. See HQ 554246, dated July

29, 1987 (Expenses incurred in transporting personnel to and from

the production facility to render services which are directly

related to the production process are includable as direct

processing costs for purposes of the CBERA.)

Compensation, including fringe benefits, of material

handlers and shipping and receiving employees is also includable

to the extent it is for handling of materials used in the

production of the subassemblies, or the finished subassemblies

themselves. See C.S.D. 80-208, dated March 24, 1980 (HQ

542035)(Cost of employees who receive, unload, and stock raw

materials in manufacturer\'s plant, distribute materials to

assembly line, maintain storage area and raw material inventory

records, and pack and prepare the eligible articles for shipment

are direct costs of processing operations for GSP purposes).

Compensation of group leaders, quality control supervisors,

and manufacturing foremen are direct processing costs to the

extent these personnel function as first line supervisors of

workers directly involved in the production operation. See HQ

554246, dated July 29, 1987. Compensation of a plant manager is

generally not considered a direct cost of the processing

operation, since such personnel ordinarily perform only

administrative functions. However, we have held that a plant

manager\'s compensation, including fringe benefits, is a direct

cost to the extent he or she functions as a first-line production

foreman. See HQ 543748, dated June 18, 1987. If the plant

manager, or other administrative personnel, perform such a

function, then a percentage of their salary and fringe benefits

related to the performance of such functions would be a direct

cost of processing operation. Id.

Compensation of maintenance personnel is a direct processing

cost to the extent they maintain equipment used in the production

of the subassemblies. See HQ 543748, dated June 18, 1987.

Similarly, the cost of engineering personnel, including fringe

benefits, is a direct cost of the processing operation if

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directly incurred in the production of the specific merchandise.

See 19 CFR 10.178(a)(1). Accordingly, a pro-rata portion of the

compensation paid to the industrial engineer may be considered a

direct processing cost to the extent his or her services relate

to the subassembly production equipment or process.

Utility costs are direct processing costs to the extent

actually incurred in production of the eligible article. See HQ

543748, dated June 18, 1987. Accordingly, the electricity used

to operate equipment in the production of the subassemblies is a

direct processing cost. A pro-rata share of the cost of

electricity used for lighting the work area where the

subassemblies are manufactured would be a direct cost of

processing (C.S.D. 80-208, dated April 23, 1980), but the cost of

electricity used for lighting or air conditioning administrative

offices would not be includable.

Depreciation on machinery and equipment that is used in the

production of the subassemblies is a direct processing cost.

See 19 CFR 10.197(a)(2), C.S.D. 80-246, dated April 23, 1980 (HQ

542097).

The Haitian inland freight charges and brokers fees

associated with the raw materials used in the production of the

subassemblies are not direct processing costs, but are properly

considered a cost of the raw materials. See 19 CFR

10.196(c)(1)(ii), HQ 554246, dated July 29, 1987. As stated

above, costs of raw materials produced in the U.S. may be

included, but in an amount not to exceed 15% of the entered value

of the articles. Costs of raw materials produced in Puerto Rico

may be included without limitation. Accordingly, if the broker\'s

fees and inland freight charges relate to U.S. produced

materials, they may be included as part of the material costs,

subject to the 15% limitation. If such costs relate to Puerto

Rican materials, they may be included as part of the materials

cost without limitation. If such charges relate to materials not

produced in the U.S., Puerto Rico, or other BC, they may not be

included.

While casualty and liability insurance is not a direct

processing cost, the costs of property insurance covering

machinery and equipment used in the production process and group

insurance provided to production employees as a fringe benefit

are includable as direct processing costs. See HQ 543748, dated

June 18, 1987. Taxes are not includable unless they meet the

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criteria of 19 CFR 10.197. See HQ 056936, dated August 22, 1978

(A pro-rata share of taxes on that part of the building used

in the processing operation is includable for GSP purposes.)

In C.S.D. 80-208, we stated that costs of janitorial

services, to the extent incurred in the plant or factory area,

were analogous to other includable items of factory overhead

necessary to production, such as electricity to keep the machines

running and heat to keep the workers comfortable. In the same

manner, we find that the facility maintenance expenses, including

compensation of maintenance personnel, are direct costs of the

processing operation to the extent they relate to the plant area

where the articles are produced. Those maintenance costs

incurred for upkeep of administrative offices or other areas of

the facility not related to the production area are not

includable.

The costs of plant security, accounting personnel, office

supplies, telephone and telex, and automobiles and trucks are not

includable as direct processing costs. See HQ 543748, dated June

18-1987, HQ 541249, dated February 24, 1977, C.S.D. 80-208, dated

March 24, 1980 (HQ 542035), and HQ 541215, dated February 25,

1977\.

In sum, items 1 through 3, 5 through 9, 13, 14, 16, 17, 19,

20, and 21 are direct costs of the processing operation subject

to the limitations discussed above. Items 4, 10, 11, 12, 15, 18,

and 22 are not direct processing costs. Item 23, which you

describe as \"miscellaneous expenses,\" must be further described.

CONCLUSION:

The subassemblies assembled in Haiti from materials of U.S.

and Puerto Rican origin will be considered products of Haiti for

purposes of the CBERA. Based on the cost information provided,

the 35 percent value-content requirement of the CBERA will be

met. Accordingly, based on the information provided, and

assuming the articles will be imported directly to the U.S., the

articles will be eligible for duty-free treatment under the

CBERA.

Sincerely,

John Durant, Director

Commercial Rulings Division