A recent dispute between an importer and U.S. Customs and Border Protection (CBP) serves as a stark reminder that the “substantial transformation” test used to determine the country of origin of imported goods is far from straightforward. As a result, gray areas abound, due in part to inconsistent precedent and a case-by-case approach to these determinations.
The decision by the Court of International Trade (CIT) in Cyber Power Systems (USA) Inc. v. United States (Slip Op. 20-130 (Ct. Int'l Trade 2020)) concerns merchandise that CBP excluded from entry into the U.S. because it believed the importer, Cyber Power Systems, was attempting to designate an incorrect country of origin. CIT denied Cyber’s motion for a preliminary injunction in favor of moving forward with the trial.
In light of this uncertainty regarding the substantial transformation test, it’s imperative that companies determine the correct country of origin before shipment. Doing so will not only help avoid detentions at the border and costly, time-consuming litigation to resolve such issues; the analysis could also lead to opportunities to obtain lower import duties and improve your bottom line.
The products at issue in the case, specifically uninterruptible power supplies and surge voltage protectors, were manufactured using hundreds of components that mostly originated in China and were assembled into finished products in the Philippines. While CBP maintains that the finished merchandise is of China origin, Cyber argues that a substantial transformation occurred in the Philippines, resulting in new and different articles of Philippine origin.
From the start, Cyber’s perfunctory responses to CBP appear to have exacerbated a disagreement that could have been resolved out of court if the importer had initially put in the effort to clearly and consistently make its points directly to CBP. Prior to filing suit, Cyber actually made a verbal prior disclosure to CBP about the issue (prompted by an investigative journalist’s discovery of “Made in China” labels under the products’ “Made in Philippines” labels). However, following that discussion, CBP sent two requests for information to Cyber before receiving Cyber’s final prior disclosure. This failure to respond in a prompt and timely fashion set the tone for the rest of the negotiations with CBP. The agency decided that it disagreed with Cyber’s assertion that the country of origin is the Philippines, issued a notice of action informing Cyber that the products are of China origin, and raised the duties owed accordingly. In its response, Cyber provided information about the relevant manufacturing steps that contradicted the facts in its prior disclosure, undermining CBP’s trust and further clouding the issue by calling into question the accuracy of the facts presented.
Cyber actually chose to ignore CBP’s decision, and continued to enter the merchandise as Philippine-origin. Then CBP detained an entry of the merchandise. When Cyber refused to change the country of origin to China, CBP excluded the merchandise. Cyber filed a protest without including the related documents, explaining that the information is available to CBP on request, further delaying the agency’s review and ultimate resolution of the matter. In response to follow-up questions from CBP, Cyber admitted that the protest also contained inaccurate manufacturing information that needed to be corrected. CBP rejected the protest, and Cyber subsequently filed suit at the CIT, followed by a motion to grant a preliminary injunction to allow its merchandise to enter the U.S.
What’s the Test?
In rejecting Cyber’s motion and insisting that the case first be tried on the merits, the court highlighted the need to review the facts in detail in light of the difficulties inherent in the 80-year-old court-created “substantial transformation” test. In an uncharacteristically blunt critique of the test, the Court acknowledged that “[w]ith 80 years of application in various contexts … the substantial transformation test should, one would anticipate, be fairly straightforward to apply. It is not.”
Under the test, manufacturing steps should effect a change in the country of origin “when an article emerges from a manufacturing process with a name, character, or use which differs from those of the original material subjected to the process.” United States v. Gibson-Thomsen Co., Inc., 27 C.C.P.A. 267, C.A.D. 98 (1940). The court acknowledged that this seemingly straightforward test has been applied inconsistently. For example, there is no consensus regarding whether it is the individual components or final product that must undergo changes in name, character, or use. This has led to some counterintuitive decisions, such as when 50 components that were assembled into a flashlight did not result in a substantial transformation because the components all retained their specific name, character, and use when assembled into the flashlight. Cases like this established the principle that mere assembly cannot effectuate a substantial transformation if it doesn’t include steps that are “sufficiently complex.” Yet the Cyber court itself acknowledged that “[e]xactly what constitutes ‘sufficiently complex’ is a bit of a mystery.”
To complicate things further, in some more recent instances CBP appears to have rejected the “name, character, or use” approach altogether, in favor of assigning the country of origin of the component that provides the product with its “essence” to the finished product as a whole. (For example, the water pump component arguably is the essence of a pet drinking fountain, so if the pump is from Japan, the country of origin of the fountain is Japan.)
Avoiding a Similar Fate
The court has decided that the dizzying list of substantial transformation principles, coupled with Cyber’s less-than-thorough responses to CBP in the communications leading up to the case, provided reason enough to deny Cyber’s pretrial request to release the merchandise into the U.S. Instead, the court insisted that for Cyber to prevail, it must develop the record by providing all substantive details necessary to support its country-of-origin determination — something the company should have done in its prior disclosure and subsequent communications with CBP.
This case illustrates how legal gray areas coupled with a company’s lax approach to country of origin and CBP requests can lead to a quagmire of litigation. But in the current environment, where tariff enforcement and special tariffs (such as Section 301 tariffs on China-origin products) are at an all-time high, companies and management should recognize the opportunity inherent in the system. Timely review to determine the correct country of origin for each product’s supply chain not only can save your company the headache of litigation; it can significantly improve your bottom line.
The following considerations can help your company remain compliant and identify opportunities for significant tariff savings:
Doreen Edelman is a partner and chair, and Andrew Bisbas an associate, in the Global Trade & Policy group of Lowenstein Sandler LLP.
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