Judge Oliver Wendell Holmes famously wrote in The Path of the Law (1897):
for the rational study of the law, the black-letter man may be the man of the present, but the man of the future is the man of statistics and the master of economics.1
Although it has been over a century since those statements were first memorialized, it appears Judge Holmes’ prediction is now a reality, as statistical methods are increasingly used not only to explain courts decisions, but also to prescribe recommended solutions to legal risks.
Ngosong Fonkem, West Virginia University College of Law 2011 (JD, MBA) and Tulane Law School 2012 (LLM), is a senior advisor at Addison-Clifton LLC, Milwaukee. He assists U.S. and foreign companies with compliance with U.S. trade laws and related audits; and with doing business in Asia.
This is of particular importance for companies that increasingly seek to restructure their global supply chains to adapt to trade disruptions associated with current global trade tensions, and also to benefit from trade preference programs.
In light of this reality, data analysis of the U.S. Custom and Border Protection’s (CBP) past rulings in cases where products have undergone manufacturing or assembly operations in various countries prior to importation into the U.S. is helpful to U.S. companies as they make investment decisions on how to structure their global supply chain operations.
Law of Substantial Transformation
U.S. law provides that if two or more countries are involved in the production of a good or its materials, the country of “last substantial transformation” determines the origin of the good.
“Substantial transformation” is assessed and determined on a case-by-case basis by examining the totality of circumstances, and it is determined to have occurred when there is a change in the product’s name, character, or use, due to manufacturing or processing operations.
Typically, the CBP analyzes the extent of operations performed, and whether the “parts lose their identity and become an integral part of a new product.”2 Assembly operations that are “minimal or simple,” as opposed to “meaningful or complex,” generally will not result in a substantial transformation.3
To determine whether an assembly operation is “meaningful or complex” enough to constitute substantial transformation, the CBP generally evaluates the following 11 factors:
- the number of components assembled;
- the number of different operations;
- how time-consuming the operations are;
- skill level required for operations;
- attention to detail required;
- value added to the article;
- overall employment generated by the manufacturing process;
- resources expended on product design and development;
- extent of post-assembly inspection and testing;
- nature of post assembly inspection and testing; and
- origin of components.
However, the CBP has stated in various cases that in doing a substantial transformation analysis, it considers the totality of the circumstances on a case-by-case basis, and no single factor is determinative.4
Analysis of ‘Meaningful and Complex’ Factors
Although the CBP has stated that it reviews every substantial transformation case presented before it on a case-by-case basis and no single factor is determinative, the lack of clarity – whether or not deliberate on its part – presents a legal risk. Such information would be helpful to companies needing to make investment decisions on how to structure their business operations to not only comply with U.S. import regulations, but also benefit from any applicable duty-savings trade preference programs or Made-in-America duty-savings treatment.
Recently, I analyzed past cases on substantial transformation to determine which of the 11 factors the CBP considers more influential to its analysis.
I reviewed a sample of 10 CBP Rulings,5 where the CBP was asked to determine whether end-items products with component parts originating from various countries were substantially transformed by undergoing manufacturing or assembly operations in a third country.
Based on the cases reviewed, the following factors had the most occurrences:
- origin of components (7/10);
- the number of components assembled (6/10);
- the number of different operations (5/10); and
- skill level required for operations (5/10).
In cases where substantial transformation was found, the factors with the most occurrences were:
- origin of components (4/6);
- the number of components assembled (4/6); and
- extent of post-assembly inspection and testing (4/6).
On the other hand, in cases where no substantial transformation was found, the factors with the most occurrences were:
- origin of components (3/4);
- the number of components assembled (2/4);
- how time-consuming the operations are (2/4); and
- skill level required for operations (2/4).
Here are the five significant key factors, based on my analysis of the data:
- the origin of the parts involved, especially major parts;
- number of parts assembled;
- the number of assembly operations required;
- the skills required for operations; and
- operation times.
The importance placed on the five key factors by the CBP in its substantial transformation determination is significant.
For example, in HQ W563491 (Feb. 8, 2007) the CBP primarily focused on the origin of key components of a multifunction machine, finding Japan and not China to be the country of origin of the machine. And in HQ H100055 (May 28, 2010), the CBP focused on the number of parts, operation steps, and time of operations, finding assembly operations in Sweden to be sufficiently complex to substantially transform the lift.
On the other hand, in HQ H030645 (Sept. 15,2008), the CBP found the labor and time spent testing the ground fault circuit interrupters in Mexico to be minimal and simple, and thus found no substantial transformation.
Single-country Originating Parts
Although the data suggest the CBP primarily focuses on the above five factors, this finding alone does not answer one key issue: how the CBP is likely to rule in a matter where a significant percentage or all of an end-item’s parts originate from a single country, but are fully assembled into a complete end-item in a third country.
While I found no seminar case or ruling addressing this specific issue, the CBP’s reasoning and decision in HQ H270580 (May 10, 2016) provides some guidance on how it is likely to rule when presented with similar sets of facts.
In this case, the CBP was asked to issue a final determination concerning the country of origin of two pieces of exercise equipment. The first scenario involved importation of all parts from China and then welding, painting, and assembly in the U.S. The second scenario was similar to the first scenario, except that some of the sub-assemblies were welded together in China.
In its analysis, the CBP found the extent of U.S. assembly operations – which included welding, cleaning, degreasing, grinding down, and spraying with paint, then assembly – to be sufficiently complex and meaningful, resulting in substantial transformation in the first scenario. Further, the skill level for the operations in the U.S. required significant education, skill, and attention to details.
In the second scenario however, the CBP found the “components that together imparted the very essence of the finished product were imported as pre-assembled.” As a result, the CBP found the processing in the U.S. did not result in a substantial transformation.
Based on HQ H270580, two key issues can be reasonably concluded to be dispositive in determining whether assembly operations in a third country is meaningful and complex resulting in substantially transformation, and thus conferring of country of origin change to the third country:
- whether the imported parts lose their identity and become an integral part of a new product when finally assembled in the third country; and
- the extent of operations performed in the third country.
On issue regarding the extent of operation in the third country, the questions are:
- whether the “essence” of the imported component change due to assembly operations, and
- whether the product requires significant additional work to create a functional product for commerce.
Observation and Conclusion
Analysis of CBP’s rulings and judicial decisions makes it clear that certain assembly operations may not be enough to establish substantial transformation.
As compliance issues remain a priority in the foreseeable future, manufacturing or assembly operations that adapt to or navigate through this complex trade environment must be of a nature that would be deemed sufficiently complex by the CBP.
1 “The Path of the Law,” Harvard Law Review 10 (1897), p. 457.
2 Belcrest Linens v. United States, 573 F. Supp. 1149 (Ct. Int'l Trade 1983), aff'd, 741 F.2d 1368 (Fed. Cir. 1984).
3 See C.S.D. 80‐111, C.S.D. 85‐25, C.S.D. 89‐110, C.S.D. 89‐118, C.S.D. 90‐51, and C.S.D. 90‐97.
4 See HQ 563110 (Oct. 20, 2004).
5 See HQ H030645 (Sept. 15, 2008); N186157 (Oct. 26, 2011); HQ W563491 (Feb. 8, 2007); HQ H294980 (May 21, 2018); HQ H022169, (May 2, 2008); HQ H296072 (July 13, 2018); HQ H282391 (Mar. 16, 2017); HQ 734050 (Jun. 17, 1991); HQ H215657 (Apr. 29, 2013); HQ H100055 (May 28, 2010).