Ruling of the Week: Origin and Value of Programmed USB
Customs and Border Protection has issued ruling HQ H308234 (Jun. 3, 2020) which covers the classification, valuation, NAFTA status, and 301 status of a USB drive with software on it. Given that a large portion of the trade community is still keenly following origin and 301 issues, it is a good ruling to review.
The products involved are the Start Me Stick and the Fix Me Stick. Both of these devices are USB stick drives containing software. The point of the Start Me Stick appears to be to access the internet while bypassing the computer to which the stick is attached. I guess the use case for that is if you use a public terminal (at a library, for example), if your current computer too slow, or if for some reason you need a wholly private browser experience that is not run through the browser on your computer. That latter might help if, say, you are looking for a new job or Tinder date via your office computer. I am not clear how this thing gets and IP address and whether activity run through it would show up in router activity logs or elsewhere, but that is not my problem.
Here is what it apparently looks like when you are using as Start Me Stick:
The Fix Me Stick is similar except that when plugged into a computer, it runs antivirus and malware scans and removes threatening software from the computer to which is is attached.
Physically, both devices are made of printed circuit board assemblies from Taiwan that include non-volatile memory. The PCBAs are shipped to China for final assembly. At this point, they are blank USB devices. From China, the drives are sent to Canada where they are flashed, meaning the software is installed onto the memory chips. The software was developed in Canada.
The first question is how to classify these things. That is not particularly hard. They are just USB drives with software on them. These are solid-state, non-volatile storage devices. Heading 8523 covers, among other things, solid-state, non-volatile storage devices whether or not recorded. That's clearly this and the actual tariff item is 8523.51.00.
Next is the question of NAFTA status. This was also not hard, but it is worth taking a look because the specifics of the rule are pretty odd.
Items of 8523.51 are subject to the following NAFTA rule:
(A) A change to prepared unrecorded semiconductor media of subheading 8523.51 from any other good of subheading 8523.51or any other subheading; or
(B) A change to recorded semiconductor media of subheading 8523.51 from any other good of subheading 8523.51 or any other subheading.
The flashing operation changes the USB drive from an unrecorded to a recorded semiconductor media of 8523.51. Note that this rule does not require a change in tariff classification; it only requires that the item go from unrecorded to recorded. There is no fallback rule based on Regional Value Content either. Had they not been recorded, the (A) rule might also have worked because the PCBA might be classified in 8523.51 and the finished but unrecorded media would also be in 8523.51.
Next, CBP considered the NAFTA marking rules to deter the country of origin for marking. This was also straightforward. The rule, in 19 CFR Part 102, requires:
A change to records, tapes and other recorded media for sound or other similarly recorded phenomenon, excluding products of chapter 37, from prepared unrecorded media for sound recording or similar recoding or other phenomena, other than products of chapter 37.
Again, this item goes from prepared and unrecorded to recorded. That means it is a product of Canada for this purpose.
Next comes the money question: Is this item subject to 301 duties? On it face, that seems unlikely. The main working component, the PCBA that contains the non-volatile memory is from Taiwan. The Chinese components are the external casing and an internal plastic holder. Presumably, though I do not know for certain, they are also lower in value that the PCBA.
But the question is whether the programming in Canada matters. It does, but only sort of. This is where I think CBP is heading in the wrong direction. First, to issue the ruling, CBP only needs to find that the item is not from China and it could do that by noting that the working parts are from Taiwan and they are not substantially transformed in China. Then, the operation in Canada is irrelevant because we know 301 duties do not apply and the NAFTA marking rules have determined that the item is a product of Canada.
But, assuming CBP wants to run through the full analysis, the question is whether programming Canada is a substantial transformation. Does the programming resulting in a new article of commerce with a new name, character, or use such that the components from Taiwan and China have become integral to the new product? For years, I would have said yes on the basis of Data General v. United States, a 1982 decision of the Court of International Trade holding that flashing a programmable memory chip causes a physical change in the electronic structure such that it becomes useful for a specific function. That, according to the Court was a substantial transformation.
In reaching that decision, the Court noted that "programs are designed by a project engineer with many years of experience in 'designing and building hardware.' While replicating the program pattern from a 'master' PROM may be the quick, one-step process to which the defendant refers, the development of the pattern and the production of the 'master' PROM require much time and expertise." The point of this was to refute the government's argument that the act of programming was a simple and, therefore, not transformative step.
From that statement, the United States has has done two things. First, it assumes the program development occurred in the U.S. That is not clearly stated in Data General. Second, it ignores the major point of the opinion which is that programming the chip causes physical changes that are equivalent to manufacturing and result in a substantial transformation. The Court stated:
It is undisputed from the evidence that programming alters the character of a PROM. Programming changes the pattern of interconnections within the PROM. A distinct physical change is effected in the PROM by the opening or closing of the fuses, depending on the method of programming. Link to the text of the note These physical alterations, not visible to the naked eye, may be discerned by electronic testing of the PROM. The electronic pattern introduced into the circuit by programming solely gives it the function as a read only memory. The "essence" of the article, its pattern of interconnections or stored memory, is established by programming. Uniroyal, Inc. v. United States, 3 CIT 219 (1982). The PROM has no function or use except for programming. In this sense, programming is equivalent to the assembly of a circuit board, which in 19 C.F.R. § 10.14(b) is cited as an example of substantial transformation.
But CBP does not follow this lead. Rather, it combines the physical manufacturing operation of programming the chip with the intangible intellectual exercise of writing the code. CBP has fairly consistently been finding that flashing chips results in a substantial transformation where the code was written and flashed in the same country. Here, CBP concluded, "Accordingly, we have generally found that programming a device in the same country where the software was written constitutes a substantial transformation."
This makes no sense to me. Programming code is an intellectual exercise that requires skill and knowledge but it does not make a thing that is, by itself, subject to the customs laws. Electronic transmissions, like phone calls and internet data, are not subject to duty, do not need to be entered, and are not generally considered to be merchandise. The physical item that embodies the intellectual effort is the merchandise. The position taken by CBP is equivalent to determining that a Stephen King novel printed in Argentina on paper from Canada is a product of the U.S. because he wrote it at his desk in Maine.
I agree that Data General indicates that programming an integrated circuit makes a physical change in the chip. The arrangement of the logic gates, which are physical switches, represent the logical steps of the code. So the "machinery" of the chip is physically changed and the use of the chip is also changed. So, that can easily be a substantial transformation. What I disagree with is that the location of the coding matters. Another analogy is to find that an iPhone from China is a product of the U.S. because the hardware was largely designed here and the code was developed here.
Reading Data General to require that the code be written in the same country in which it was flashed to the chips is an overextension of a fact stated in the decision. It is is similar to the emphasis CBP has placed on parts having a "predetermined end use," which is a gross overextension of the opinion in National Hand Tools. This kind of analysis adds layer upon layer to the "new name, character, or use" test to make that phrase little more than the title for a far more complex and less predictable test. CBP really should walk this trend back and the Court of International Trade should facilitate that by trying to refocus on the core of the test rather than trying to reconcile the entire history of all origin cases each time a new one arises.
All of that said, Customs found that flashing the Canadian code in Canada was a substantial transformation. As such, the item is Canadian and not subject to the Section 301 duties applicable to products of China.
The last bit is whether the value of the code is included in the transaction value of the USB drives. As a general rule, the U.S. does not require that the value of software on a carrier medium be included in the transaction value of the imported medium. That applies, for example, to magnetic and optical disks. See T.D. 85-124 (1985). But, there is an exception for data or instructions stored on integrated circuits, semiconductors and similar devices or articles incorporating them. So, the value of the code needs to be added to the value of these USB drives.
That is many more words than I expected to use to explain this. That has much to do with the fact that I think the origin determinations for electronics is unnecessarily confused, in part by the focus on the intangible intellectual property. But, there you have it, a full run down on the FixMeStick and StartMeStick.