The US Court of International Trade (CIT) recently addressed what constitutes “substantial transformation” for purposes of determining country of origin (COO) for US government procurement purposes under the Trade Agreements Act of 1979 (TAA). Energizer Battery, Inc. v. United States, 2016 WL 7118538 (Ct. Intl. Trade 2016). The case is one of first impression for the CIT, which has jurisdiction to review final determinations of US Customs and Border Protection (CBP).1 The opinion provides additional guidance on the interpretation and application of the TAA for government procurement purposes. Previous Steptoe advisories on application of the TAA for government procurement purposes can be found here.
The CIT case involved a second generation (Generation II) military flashlight produced by Energizer. The case came before the CIT on a challenge by Energizer to a CBP ruling that the country of origin of the Generation II flashlight was China, which would make the flashlight ineligible for government procurement under the TAA. The issue with respect to the Generation II flashlight focused primarily on whether assembly in the US of components, “virtually all of which” according to the CBP, were of Chinese origin, constituted substantial transformation. The Court, after conducting a de novo review of the record before it,2 also concluded China was the country of origin of the Generation II flashlight for government procurement purposes.
The CIT first observed judicial interpretations of substantial transformation for purposes of government procurement under the TAA have been few and far between, and therefore looked to decisions construing language identical to the TAA in cases arising in other customs areas such as marking. The court noted the test for substantial transformation is fact specific and looks at whether the article underwent a process “such that ‘a new and different article [has] emerge[d], having a distinctive name, character, or use.’” (Citation omitted). It also observed that “[c]ourts have primarily focused on changes in use or character” in assessing whether there has been substantial transformation, and a change in name is the “least compelling of the factors.”
The CIT also observed that in assessing whether there has been a change in “character,” some courts have looked to the “essence” of the completed article “to determine whether an imported article has undergone a change in character as a result of post-importation processing.” It also noted that “when the post-importation processing consists of assembly, courts have been reluctant to find a change in character, particularly when the imported articles do not undergo a physical change.” With respect to change in use, it stated courts have “found that such a change occurred when the end-use of the imported product was no longer interchangeable with the end-use of the product after post–importation processing,” but that “when the end-use was predetermined at the time of importation, courts have generally not found a change in use.” Finally, it pointed out that courts have considered various “subsidiary or additional factors, such as the extent and nature of operations performed, value added during post-importation processing, a change from producer to consumer goods, or a shift in tariff provisions.” However, it also observed there is no uniform or exhaustive list of those factors and consideration of them “is not consistent,” noting that some courts have distinguished “minor manufacturing,” or simple assembly, from more complex processes.
With respect to the Generation II flashlight, the CIT found the assembly operations in the US did not result in substantial transformation, primarily because the post-importation assembly operations “[did] not result in a change in the shape or material composition of any imported component . . . [such that] there is no change in character as a result of Energizer’s assembly operations.” The CIT also held that the imported components did not undergo a change in name or use when they were assembled in the US. With respect to the latter, the court rejected Energizer’s argument that its assembly process was transformative because “none of the . . . components could function as a flashlight at the time of importation and all of them became integral parts of a new commercial product.” Significantly, the court noted that where, as with the Generation II flashlights, components “are imported in a pre-fabricated form with a predetermined use, the assembly of those articles into a final product, without more, may not rise to the level of substantial transformation.” The court also found the post-importation processing was “not sufficiently complex as to constitute substantial transformation.”
Finally, the CIT also rejected Energizer’s reliance on the US share of production costs (there, 45%) as supporting its position that the US operations resulted in substantial transformation. It noted this was a “subsidiary factor” and suggested that those costs were attributable of approximately seven minutes of labor.
The CIT’s decision points to three important considerations in concluding country of origin for government procurement compliance under the TAA.
First, the court confirmed the analysis of “substantial transformation” in judicial (and CBP), decisions in other contexts (such as determinations of the country of imported goods for marking purposes), are relevant to the analysis of COO for government procurement purposes. Indeed, the CBP often looks to its prior decisions involving country of origin for marking purposes when assessing substantial transformation of similar products for government procurement purposes under the TAA.
Second, the CIT’s analysis makes clear that certain assembly operations may not be “enough” to establish substantial transformation. For example, an assembly operation involving relatively simple operations or, as with the Generation II flashlight, input parts (or subassemblies), already shaped and committed for use only in the finished product, may not be sufficient to establish substantial transformation. Accordingly, companies should assess assembly operations with an objective and critical eye in assessing whether such operations are sufficiently complex to change the “character” of the input items. Again, past CBP rulings and judicial decisions that analyze assembly similar operations to those under consideration can be important in the analysis of whether a particular process is likely to constitute substantial transformation for government procurement purposes. This analysis could include examination of the actual, physical steps in the relevant assembly operation, including their complexity and required level of expertise.
Finally, the CIT explicitly embraced the traditional “name, character and use” test for substantial transformation. Unlike other country of origin regimes, for example, the Buy American Act, this test does not expressly include a percentage of local value added or content standard to establish COO for US government procurement purposes. As noted above, the CIT in Energizer Battery described the value added during post-importation processing as a “subsidiary factor” in its analysis. Thus, the percentage of costs associated with US-based activity in the total cost of an item while relevant, may not be dispositive.