HQ 000131: CFTA; transformation; originating; intermediate material; value of material defined; price paid; vertically integrated producer; General Note 3(c)(vii)(M)

Native CBP ruling rendition. Applicability is fact-specific; modification/revocation relationships and original publisher date are retained. Publisher sentinel year0001 means unknown date, not a historical legal adoption.

                           HQ 000131

                        December 12, 1991

CLA-2 CO:R:C:M  000131 JLV

CATEGORY:  Classification

Director
Office of Regulatory Audit
U.S. Customs Service
1301 Constitution Avenue, NW
Washington, D.C.  20229

RE:  CFTA; transformation; originating; intermediate material;
     value of material defined; price paid; vertically integrated
     producer; General Note 3(c)(vii)(M)

Dear Sir:

     This is in reference to your request for Internal Advice in
which you request a determination from this Office pursuant to 19
CFR 177.11 concerning the application of the rules of origin in
the United States-Canada Free-Trade Agreement (CFTA) to an
"intermediate" material produced and then used by a vertically
integrated producer in the production of a final product
exported to the United States.

FACTS:

     In a situation described by you, a vertically integrated
producer uses third-country materials in the production of its
goods.  However, at a specific point in the production of these
goods, the producer claims that it has produced an
"intermediate" material which should be considered as a material
originating in the territory of Canada.  The producer then
continues with its production process and incorporates this
intermediate material into its finished goods which are exported
and for which CFTA benefits are claimed.  Because the exported
goods are subject to a value-content requirement, the producer
claims the value of the intermediate material as a territorial
cost for purposes of satisfying the value-content requirement for
its exported goods.

ISSUES:

      1) Whether a vertically integrated producer can claim an
"intermediate" material as an originating material for purposes
                              - 2 -

of qualifying a finished product exported to the U.S. as a "good
originating in the territory of Canada."

     2) Assuming the intermediate material can be so claimed,
what is its value for purposes of applying any value-content test
embodied in the CFTA rules of origin?

LAW AND ANALYSIS:

     The analysis of any issues arising under the CFTA must begin
with the United States-Canada Free-Trade Agreement Implementation
Act of 1988, P.L. 100-449, 102 Stat. 1851 ("CFTA Act").  The CFTA
was negotiated pursuant to authority provided in section 102(b)
of the Trade Act of 1974, as amended by the Trade and Tariff Act
of 1984.  The CFTA, together with the CFTA implementing
legislation, was submitted to Congress for approval under "fast-
track" procedures outlined in the Trade Act of 1974.  The CFTA
Act is the implementing legislation submitted by the President,
which was approved by Congress under "fast-track" procedures
without amendment.

     However, as noted by the Senate Finance Committee,
     [n]ot all provisions of the agreement are reflected by
     provisions in the implementing legislation.  Many
     obligations of the Agreement require no action on the
     part of the United States to effect implementation
     because U.S. law or practice is already consistent with
     the Agreement.  Other obligations can be implemented
     through administrative action, while many provisions
     affect only outstanding rules and regulations of
     Canada. Senate Report No. 100-509, p. 7.

     The rules of origin are reflected in the provisions of the
implementing legislation. Section 202 of the CFTA Act closely
tracks the rules of origin contained in the CFTA itself.  "It,
therefore, provides direct legislative implementation of these
[rules of origin] provisions into U.S. law."  Senate Report No.
100-509, p. 15.  Consequently, with regard to the issues under
consideration in this opinion, Congress has provided specific
legislation and, therefore, the normal rules of statutory
construction apply.

     Before engaging in statutory analysis of the particular
provisions at issue, it is important to understand that the
analysis is framed by clear guidance from the U.S. Supreme Court.
Such guidance is critical because "the judiciary is the final
authority on issues of statutory construction and must reject
administrative constructions which are contrary to clear

                              - 3 -

congressional intent."  Chevron U.S.A. Inc. v Natural Resources
Defense Council, Inc., 467 U.S. 837, 843 n.9 (1984).  To ensure
that our analysis is consistent with any judicial analysis which
might subsequently occur, we look to the U.S. Supreme Court for
guidance.  The Court has repeatedly emphasized that statutory
interpretation must be consistent with the language of the
statute itself, see, e.g., Reiter v. Sonotone Corp., 442 U.S.
330, 337 (1979), and it is assumed "that the legislative purpose
is expressed by the ordinary meaning of the words used."
Richards v. U.S., 369 U.S. 1, 9 (1962).  Thus "[a]bsent a clearly
expressed legislative intention to the contrary, that language
must ordinarily be regarded as conclusive."  Consumer Product
Safety Commissioner v. GTE Sylvania, Inc., 447 U.S. 102, 108
(1980).

     However, "[t]he decisions of this Court have repeatedly
warned against the dangers of an approach to statutory
construction which confines itself to the bare words of a
statute."  Lynch v. Overholser, 369 U.S. 705, 710 (1962).  If a
literal reading of a statute is "contrary to the congressional
intent and leads to absurd conclusions," it must be rejected.
U.S. v. Bryan, 339 U.S. 323, 338 (1950).  "[S]tatutes always have
some purpose or object to accomplish, whose sympathetic and
imaginative discovery is the surest guide to their meaning."
Cabell v. Markham, 148 F.2d 737, 739, aff'd, 326 U.S. 404 (1945).
However, and admittedly coming full circle, the U.S. Supreme
Court recently provided valuable guidance in the context of the
issues before us.

     As the Court stated in Board of Governors v. Dimension
Financial Corp., 474 U.S. 361, 373-74 (1986):

     The plain purpose of legislation, however, is
     determined in the first instance with reference to the
     plain language of the statute itself. . .  Application
     of 'broad purposes' of legislation at the expense of
     specific provisions ignores the complexity of the
     problems Congress is called upon to address and the
     dynamics of legislative action.  Congress may be
     unanimous in its intent to stamp out some vague social
     or economic evil; however, because its Members may
     differ sharply on the means for effectuating that
     intent, the final language of the legislation may
     reflect hard-fought compromises.  Invocation of the
     "plain purpose" of legislation at the expense of the
     terms of the statute itself takes no account of the
     processes of compromise and, in the end, prevents the
     effectuation of congressional intent. Id.

                              - 4 -

     This latest guidance is critical to our analysis.  The
complexity of the problems the Administration faced in
negotiating the CFTA and Congress faced in its deliberations
regarding the implementing legislation were obviously compounded
by the dynamics of the "fast-track" procedures.  The CFTA itself
reflected hard-fought compromises and Congress recognized this
fact.  See, e.g., United States-Canada Free-Trade Agreement:
Hearing Before the Committee on Governmental Affairs, 100th
Congress, 2nd Sess. S. Hrg. 100-855, p. 8 et seq. (May 9, 1988).
The CFTA Act submitted to Congress reflected those compromises.
While Congress may have disliked certain  provisions, it could
not amend the legislation under "fast-track" procedures.  Given
the unique circumstances under which this particular legislation
was enacted, the final caveat of the U.S. Supreme Court quoted
above must be carefully weighed in rendering this opinion.  In
the absence of clearly expressed congressional intention in the
legislative history on any particular issue, "the terms of the
statute itself" should be controlling given the fact that
Congress had to enact it as written.  Id.

     In order to resolve the issues presented above, the unique
CFTA rules of origin embodied in Section 202 of the CFTA Act must
be examined.  Those rules are contained in General Note 3(c)(vii)
of the Harmonized Tariff Schedules of the United States, 19
U.S.C. 1202, as amended ("HTS").

     General Note 3(c)(vii)(A) provides that "goods originating
in the territory of Canada" are eligible for CFTA treatment.
General Note 3(c)(vii)(B) provides as follows:

     goods imported into the customs territory of the United
     States are eligible as "goods originating in the
     territory of Canada" only if--

       (1) they are goods wholly obtained or produced in
       the territory of Canada and/or the United States,
       or

       (2) they have been transformed in the territory of
       Canada and/or the United States, so as to be
       subject--

          (I) to a change in tariff classification as
          described in the rules of subdivision
          (c)(vii)(R) of this note, or

          (II) to such other requirements subdivision
          (c)(vii)(R) of this note may provide when no
          change in tariff classification occurs, and


                              - 5 -

          they meet the other conditions set out in
          subdivisions (c)(vii)(F), (G),(H),(I),(J) and
          (R) of this note.

     For purposes of our analysis, we are using, as an example,
an automobile because the ruling request has arisen specifically
with regard to an audit of an automobile producer's claim for
duty-free treatment for its automobiles imported from Canada as
originating goods under the CFTA rule of origin.  These
automobiles are not "wholly obtained or produced" in Canada.
Therefore, to determine whether they qualify for preferential
duty treatment as "goods originating in the territory of Canada,"
the analysis must begin with subdivision (c)(vii)(B)(2).

     Essentially, subdivision (c)(vii)(B)(2) requires a
transformation of the goods "in the territory of Canada, so as to
be subject to" or satisfy the rules of subdivision (c)(vii)(R).
The rules under subdivision (c)(vii)(R) are initially broken out
by HTS sections.  Therefore, the HTS must be reviewed to
determine where the imported articles are classified.
Automobiles are classified under HTS Heading 8703, providing for
"Motor cars and other motor vehicles principally designed for
the transport of persons (other than those of heading 8702),
including station wagons and racing cars".  Automobile bodies,
and automobile parts, components and accessories also are
generally classified under Chapter 87 of the HTS.

     Consequently, both the finished automobile as well as
automobile parts and/or components are subject to the
transformation requirements of subdivision (c)(vii)(R)(17) for
articles classifiable in Chapter 87:

     (17) Section XVII: Chapters 86 through 89.

       (aa) A change from one chapter to another.

       (bb) A change to any heading of this section (other
       than a heading within the groups 8701 through 8705
       or 8901 through 8905) from another heading other
       than a parts heading.

       (cc) A change to any heading of this section from a
       parts heading; or within any heading, a change to
       any subheading from a parts subheading; provided,
       that the value of materials originating in . . .
       Canada . . . plus the direct cost of processing
       performed in . . . Canada . . . constitute not less
       than 50 percent of the value of the goods when
       exported to the . . . United States.

                              - 6 -

       (dd)  A change to headings 8701 through 8705 from
       any other heading; provided, that the value of
       materials originating in . . . Canada . . . plus
       the direct cost of processing performed in . . .
       Canada . . . constitute not less than 50 percent of
       the value of the goods when exported to the . . .
       United States.

       (ee) A change to headings 8901 through 8905 from
       any other headings; . . .

     A change in classification arising from the transformation
of automobile components classified under heading 8707 or 8708 to
automobiles classified under heading 8703 may be subject to
either (cc) or (dd) above.  Under the CFTA rules of
interpretation a more specific rule takes precedence over a more
general rule.  General Note 3(c)(vii)(K).  Therefore, the rule
governing the transformation of the automobile body from heading
8707 or automobile parts from heading 8708, to an automobile
under heading 8703, is set forth in subparagraph (dd).

     Furthermore, as will be discussed more fully below, if the
automobile is to qualify as a "good originating" in Canada under
the rules provided for in subdivision (c)(vii)(R), the value of
"materials originating" in Canada and/or the U.S. used or
consumed in the production of the automobile plus the direct cost
of processing must constitute "not less than 50 percent of the"
value of the [automobile] when exported to the territory of the
United States."  This value-content requirement also affects the
qualification of intermediate materials consisting of assembled
automobile parts.

Issue 1:

   MAY A VERTICALLY INTEGRATED PRODUCER CLAIM AN INTERMEDIATE
   MATERIAL AS AN "ORIGINATING MATERIAL" FOR PURPOSES OF
   QUALIFYING A FINISHED PRODUCT EXPORTED TO THE U.S. AS A "GOOD
   ORIGINATING IN THE TERRITORY OF CANADA."

     For purposes of this analysis, a vertically integrated
producer is considered to be an entity which produces a product
for export from materials which that producer in turn has made.
Further, these materials shall be referred to in this analysis as
"intermediate" materials. The initial issue is whether, and under
what circumstances, an intermediate material used in the
production of the exported product can be claimed as
"originating material" for purposes of qualifying the exported
product as a "good originating" in Canada.

                              - 7 -

     There is nothing expressed directly in the CFTA or the CFTA
Act which would prevent a vertically integrated producer from
claiming an intermediate material as an "originating material."
No express distinction between vertically integrated producer
and non-integrated producers is made.  The CFTA test is straight-
forward.  Chapter 2 of the CFTA defines the term "originating"
to mean "qualif[ies] under the rules of origin set out in Chapter
Three [of the CFTA]."  These rules were implemented in Section
202 of the CFTA Act and are set forth in General Note 3(c)(vii)
of the HTS.  These provisions expressly provide rules of origin
to be used to determine whether "goods originat[e]" in Canada.
The term material is defined in General Note 3(c)(vii)(P) to mean
"goods, other than those included as part of the direct cost of
processing or assembling, used or consumed in the production of
other goods."  Consequently, to determine whether material is
"originating material," the definition for "material" in General
Note 3(c)(vii)(P) should be considered and the rules of origin
provided in the CFTA to determine whether "goods" are originating
should be utilized.  By definition, therefore, a material is
"originating material" if it is a good used or consumed in the
production of other goods and qualifies under the rules of
origin.

     In certain instances, in addition to meeting the requisite
change in classification, a material must itself also satisfy a
"value-content" test.  In this case, the test is set forth in
subsection (c)(vii)(R)(17)(dd) as follows:

     the value of materials originating in . . .  Canada
     and/or the United States plus the direct cost of
     processing performed in  . . . Canada and/or the United
     States constitute not less than 50 percent of the value
     of the [intermediate] goods when exported to the  . . .
     United States. (underscoring added)

However, a threshold question is whether an intermediate
material can qualify if that material is not exported in its
intermediate condition to the United States, given the statutory
language "when exported to the . . . United States."  It is our
view that the intermediate material can be considered "exported"
for purposes of applying the value-content test when the finished
product of which it is a part is exported.  A vertically
integrated producer may then treat this intermediate material as
"originating material" for purposes of determining whether its
finished product qualifies as a "good originating" in Canada.

     Our conclusion is supported both by the legislative history
of the CFTA Act and by General Note 3(c)(vii)(F).  General Note
3(c)(vii)(F) provides:

                              - 8 -

     Whenever the processing or assembly of goods in the
     territory of Canada and/or the United States results in
     one of the changes in tariff classification in Canada
     described by the rules set forth in subdivision
     (c)(vii)(R) of this note, such goods shall be
     considered to have been transformed in the territory of
     Canada and shall be treated as goods originating in the
     territory of Canada, provided that such processing or
     assembly occurs entirely within the territory of Canada
     and/or the United States and that such goods have not
     subsequently undergone any processing or assembly
     outside of Canada or the United States that improves
     the goods in condition or advances them in value.
     (emphasis added)

     To interpret the export requirement in the value-content
test of subsection (c)(vii)(R) so as to require that the
intermediate material be exported in its intermediate condition
in order to qualify as "originating material" would be to ignore
the plain language of General Note 3(c)(vii)(F) entirely.  To
paraphrase the U.S. Supreme Court, "doubts which may arise upon a
cursory examination of [the value-content test] disappear when
they are read, as they must be, with every other material part of
the statute . . . and in light of their legislative history."
White v. U.S., 305 U.S. 281, 292 (1938).

     Because subsections (c)(vii)(F) and (c)(vii)(R)(17)(dd) are
part of the same act, they should be read in pari materia, that
is, the provisions "should be construed together with the purpose
of making them harmonious."  Heiden v. Cremin, 66 F.2d 943, 946
(8th Cir. 1933).  Reading the two provisions together, an
"intermediate material" may qualify as an originating material
under the rules of origin, notwithstanding that it is not
exported in its intermediate condition, so long as such material
"ha[s] not subsequently undergone any processing or assembly
outside of Canada or the United States that improves the goods in
condition or advances them in value."  The natural corollary to
that proviso is that any further processing or assembly occurring
inside Canada or the United States should not disqualify the
intermediate material.

     This interpretation of the rules of origin is supported by
the legislative history.  This issue was raised and addressed
during the congressional hearings in a manner consistent with our
opinion.  The House Committee on Energy and Commerce included in
its report recommending passage of the implementing legislation a
letter from the U.S. Trade Representative which responded to
questions raised by the Committee regarding the CFTA.  In
pertinent part, the letter provided:

                              - 9 -

     (c) Can vehicle parts that are not wholly of Canadian
     materials be counted as Canadian for the purpose of
     meeting the 50 percent value-content test on finished
     vehicles?

       As noted above, articles that are not wholly of U.S.
     or Canadian materials may become treated as U.S. or
     Canadian if the third-country materials have been
     sufficiently processed (in the U.S. and/or Canada) to
     satisfy one of the individual rules of origin. . . . In
     the case of vehicle parts, if one of the rules of
     origin is satisfied then the finished vehicle part is
     considered as Canadian (or United States,) even though
     it may contain some third-country materials.

House Report No. 100-816, Part 7, p. 52.

     For the reasons provided above, we conclude that a
vertically integrated producer may claim an intermediate
material as an "originating material" for purposes of qualifying
a finished product exported to the U.S. as "goods originating in
the territory of Canada."

Issue 2:

     WHAT IS THE VALUE OF AN INTERMEDIATE MATERIAL FOR PURPOSES
     OF APPLYING THE VALUE-CONTENT TEST EMBODIED IN THE CFTA
     RULES OF ORIGIN?

      The "value of materials originating" in Canada is expressly
defined in General Note 3(c)(vii)(M) as "the price paid by the
producer of exported goods for materials originating in . . .
Canada and/or the United States . . .  or for materials imported
from a third country used or consumed in the production of such
originating materials" plus certain other indirect costs not at
issue herein.

     When a vertically integrated producer manufactures its own
materials (in part from third-country materials) so as to result
in originating intermediate materials, there obviously is no
"price paid" by the vertically integrated producer for the
intermediate material originating in Canada.  Rather than
purchasing the "originating material," the producer manufactured
it.  Therefore, the first clause of subdivision 3(c)(vii)(M)(1),
i.e., "the price paid by the producer of exported goods for
materials originating in . . . Canada . .," does not apply.

     However, the express language of the second clause of
subdivision 3(c)(vii)(M)(1) does apply.  That subdivision

                             - 10 -


provides that the "value of the materials originating in" Canada
means the "price paid by the producer of exported goods . . . for
materials imported from a third country used or consumed in the
production of such originating materials . . ." General Note
3(c)(vii)(M)(1).  Therefore, because "materials imported from a
third country [were] used or consumed in the production of such
[claimed] originating materials," by definition the "value of
[such] material originating" in Canada is limited to the "price
paid" for such third country materials.  General Note
3(c)(vii)(M). (emphasis added).

     This application of the plain language of the statute may
at first blush, appear to lead to incongruous results.
"Originating material" assembled from both foreign and domestic
subcomponents is valued at the price paid for the foreign
subcomponents, rather than including the price paid for the
domestic components.  Nevertheless, this result is mandated by
the plain language of the statute.  In addition, further analysis
demonstrates the appropriateness of this interpretation.

     With regard to domestic components, such as domestic steel
coil used to produce intermediate materials such as body panels,
an auto exporter may, of course, claim the purchase price of such
steel coil when attempting to qualify the automobile for CFTA
treatment.  The "value of materials originating" in Canada is
always, in the first instance, "the price paid by the producer of
exported goods for materials originating in . . . Canada and/or
the U.S."  Our decision does not affect the automobile exporter's
ability to claim the purchase price of the steel coil or any
other domestic material when attempting to qualify the exported
product.  It must be remembered that the vertically integrated
producer is not required to claim any intermediate material as
"originating material."  A producer may elect to claim such
intermediate material as "originating material" for purposes of
the value-content test.

     A further example illustrates the applicability of this
definition to the value-content test.  An automobile producer
purchases and imports foreign fabricated body panels to be joined
with the domestically fabricated body panels (produced from
territorial steel coil purchased by the automobile producer) to
form a body.  The production of a body from third-country body
panels and territiorial body panels would not affect the
producer's ability to claim the price paid for the domestic steel
coil for purposes of qualifying the automobile under the CFTA
rules of origin.

     However, if the automobile producer wants to qualify its
finished good (the automobile) by including the price paid for
                             - 11 -

the foreign fabricated body panels, the producer must claim the
body as "originating material."  One purpose for claiming the
body as the originating intermediate material is to provide an
opportunity to claim, for purposes of qualifying the automobile,
its relatively higher costs reflected in the price paid for any
foreign fabricated parts assembled into the body.  Assuming the
body qualifies as "originating material," our opinion interprets
the plain language of General Note 3(c)(vii)(M) to mean that the
value of the body for purposes of qualifying the automobile is
limited to the price paid for the foreign fabricated body panels.
It must be remembered that the value of any domestic materials
such as the domestic steel coil was used to qualify the body as
"originating material."  The value of this domestic material does
not evaporate.  Rather, the automobile exporter must elect how
that "value" is to be used under the CFTA rules, either to
qualify the automobile or the body.  Once elected, the statutory
rules dictate the consequences of that choice.

HOLDING:

     A vertically integrated producer can claim an intermediate
material as an "originating material" for purposes of qualifying
a finished product exported as "goods originating in the
territory of Canada" for purposes of the CFTA.  This material
must be a material as defined in General Note 3(c)(vii)(P) and
must itself qualify under the CFTA rules of origin.

     For purposes of applying a value-content test in the CFTA
rules of origin, the value of an "originating material" which is
made by a vertically integrated producer is the price the
producer paid for the materials imported from a third country
which were used or consumed in the production of the originating
materials plus, where applicable, certain other costs
specifically set forth in General Note 3(c)(vii)(M)(2)(I - IV).


                              Sincerely,




                              Harvey B. Fox
                              Director
                              Office of Regulations and Rulings