Ruling of the Week 2015.27: Prototypes and Double Taxation

This is a review of what I will call a "classic" Customs and Border Protection ruling about which everyone in the trade should be familiar. In this case, we are talking about HQ 545907 (Oct. 11, 1996), which is the reconsideration of HQ 545278 (Apr. 7, 1994).

This ruling involves a contract between Ford Motor Company and Yamaha Motor Company. Under the terms of the deal, Yamaha was to design and develop a modified Ford engine. Ford agreed that it would purchase any prototypes Yamaha made. If the program was successful, Ford agreed to enter into a contract for the purchase of the modified engines.

To develop the modified engine, Yamaha produced 178 prototypes, which were purchased by Ford. Ford imported 156 of the prototypes and paid duty on them based on the price paid to Yamaha. Note that this is 1996, before tariff item 9817.85.01 was added to the tariff. The program was a success and Ford started importing the engines.

The relevant question is whether the sums Ford paid to Yamaha for the prototypes, some of which were imported and subject to duty, are to be included in the value of the engines imported for purchase by Ford. In the initial ruling, Customs held that the payments for the prototypes were inextricably linked to the cost of developing the modified engine. As such, those payments for the prototypes were part of the price paid or payable for the production engines and, therefore, subject to duty again when Ford imported the engines.

Ford raised several good points. First, it pointed out that this result violates the principle against double taxation. Here, the prototypes have already been subject to duty based on their declared value. That value, according to Ford, should not be subject to duty again. That is obviously true as it creates a disincentive to perform any part of the testing in the U.S. Had Ford tested them in Japan, this would never have been a problem.

In the request for reconsideration, Customs stuck to its original position. According to Customs, payments for the development of samples and prototypes are usually considered to be part of the price paid or payable for the subsequent production merchandise. Here, the prototypes were inextricably linked to the cost of developing the new engines. As such, payment for the prototypes are part of the total price paid for them. Because the prototype engines were not returned to Yamaha, they were not assists. But, the payments remain part of the total price paid or payable for the final production engines.

Most of the sting of this ruling has been mitigated by the addition of HTSUS item 9817.85.01, which provides for duty free entry of "Prototypes to be used exclusively for development, testing, product evaluation, or quality control purposes . . . ." There are a number of relevant Chapter Notes regulating the application of this provision. When trying to use 9817.85.01, be sure that the merchandise legally qualifies as a prototype for development, testing, etc. A similar result could be accomplished by using a Temporary Importation Bond or possibly drawback (if the prototypes or equivalent products are exported or destroyed).

Despite there being several strategies by which to avoid this issue, it continues to surprise some people that this is the rule. Companies that do not have good policies and procedures for handling prototypes can end up with a big, unexpected duty bill. This can happen when engineers, for example, arrange for prototypes to be shipped directly to them, outside of the normal compliance process. Don't let that happen. If your company imports prototypes, samples, evaluation items, ofr similar pre-production goods, make sure there is a well-published and understood process to making those entries. And, be sure to let your broker know that a shipment contains prototypes. A bit of upfront work on this front can avoid significant headaches later.


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