IMPORT ADMINISTRATION POLICY BULLETIN Number 92.2 Date of Issue: July 29, 1992 Topic: Differences in Merchandise; 20% Rule Approved: (signed) Alan M. Dunn Assistant Secretary for Import Administration Statement of Issue When to make and how to quantify adjustments for differences in merchandise; 20% limit on adjustment. Analysis The statute (Section 772 (a) (4)) provides allowance may be made when the product on which foreign market value (FMV) is based is not identical to that exported to the United States. The regulations (Section 353.57) provide that the allowance will normally be based on differences in cost of production, but may be based in differences in market value. In practice, and for the reasons cited in the 1985 Study of Antidumping Adjustments Methodology, we have rarely been able to determine the direct price effect of a difference in merchandise (Diffmer). Therefore, diffmer adjustments are based almost exclusively on the cost of the physical difference. We do not make an adjustment because the cost of production is different; we are measuring the difference in cost attributable to the difference in physical characteristics. Note that the regulations specify that no consideration will be given to cost of production differences when the compared merchandise has identical physical characteristics. Therefore, it is important in any consideration of a diffmer to isolate the costs attributable to the difference, not just assume that all cost of production differences are caused by the physical differences. When it is impossible to isolate the cost differences, we should at least determine that conditions unrelated to the physical difference are not the source of the cost differences, such as when different facilities are used, or the cost differences are high but the actual physical differences appear small. If the costs of the physical difference cannot be isolated or it is not reasonably clear that the differences in production cost are related to the physical difference, no adjustment should be made. It is recognized that no fixed rule can be made here; much depends on the types of product and the physical differences in the merchandise in each case. Yet, there should always be a recognition that it is the physical differences for which the adjustment is made, that we know precisely what those differences are, and that the cost differences which form the adjustment are related to those physical differences and not extraneous factors. In making a cost-based diffmer allowance the Department uses only variable and semi-variable manufacturing expenses in quantifying the cost differences. Fixed manufacturing costs such as space heating, lights, and depreciation of plant and equipment are not part of the adjustment, nor are general, selling, and administrative expenses, or profits. We do not adjust for profit; to do so would be making the adjustment on the basis of value differences (though constructed, rather than observed), since the selling price is a factor in determining profits. Non-variable expenses are normally incurred regardless of whether the difference exists or not. For example, if a switch is added to a widget sold in the home market, but the exported item is without the switch, only the cost of the switch, the labor to install the switch, supervisory labor, and the power to run the machinery would be allowed, since these are the only additional expenses that are incurred because the difference existed. We are assuming that the overhead expenses of the producer remain unchanged and that the producer will only pass on the customer, thus directly affecting the price, those expenses additional to the expenses he would have incurred if the switch had not been installed. This is similar in a way to the economic convention that taxes on the producer are absorbed and taxes on the product are passed to the purchaser. Since, as in the case of taxes, we know that the convention is probably not always strictly true, but cannot determine just what portion of fixed costs might be passed on, the need to limit the adjustment is necessary. Otherwise, as the physical differences become larger and larger, the full, but indeterminable affect on commercial value of whatever share of factory overheads, GS&A expenses, or profits might be passed on grows. To limit the potential differences in commercial value caused by physical differences, we employ the 20% guideline. If the commercial value of two products is greatly different, then a comparison is not reasonable; the difmer adjustment, being limited to variable manufacturing costs probably cannot fully compensate. While we know we cannot accurately measure the impact of all costs on commercial value, we expect that there is some impact. When the variable cost difference exceeds 20%, we consider that the probable differences in values of the items to be compared is so large that they cannot reasonably be compared. Since the merchandise is not identical, does not have approximately equal commercial value, and has such large differences in commercial value that it cannot reasonably be compared, the merchandise cannot be considered similar under Section 771 (16) (A), (B),or (C) of the statute. Although the 20% guideline has been used for a number of years, there have been some difference in practice in the calculation formula. While the numerator has always been the difference in variable production cost, different denominators have been used. They have sometimes been price, other times total manufacturing cost, and yet other times the total variable manufacturing costs. While a case could be made for each of these, consistency of application is necessary. Upon further consideration, we have determined that price is not the best denominator since it both varies from sale to sale, and may be affected by dumping. Because variable manufacturing costs change as a share of total manufacturing costs from product to product, the size of a 20% difference would consequently vary as well in relation to both the price and total manufacturing costs. Therefore, a more stable basis for the denominator is the total manufacturing costs, and it has been chosen for uniform use. The 20% guideline is just that, a guideline and not an inflexible rule. There may be instances in which comparisons may be reasonable even if the diffmer is in excess of 20% of the cost of manufacture of the U.S. model. For instance, if there are very small fixed cost differences, such as when the physical difference is a subcontracted operation or outside purchase, the potential for distortion in the quantification is less. Also, if the comparisons with greater than 20% diffmer adjustments are only a small portion of the total comparisons, the possible impact of the over 20% diffmers may be minor in relation to the greater expense to all parties of having to develop constructed values. Similarly, the determination that reasonable comparability ends at a 20% diffmer is not so precise that one can say a diffmer of over 20% means comparability is never achieved. The 20% guideline is, however a point of departure in the analysis, and cannot be ignored. Any use of comparisons with greater than 20% diffmers must be explained. Any relevant special conditions, such as those above, should be analyzed, as well as the amount by which the diffmer exceeds 20%. Unless we can explain how the comparison remains reasonable, or distortion is minimized, we should not make comparisons when diffmers exceed 20%. Instead, when there is no other similar merchandise, we should revert to constructed value, or in the case of an investigation, consider whether inclusion of the affected sales is necessary to support a final determination. Statement of Policy Sales of products in domestic or third country markets with variable manufacturing cost differences exceeding 20% of the total average cost of manufacture, on a model specific basis, of the product exported to the United States will normally not be utilized in determining foreign market value. Any use of products with the cost of merchandise differences exceeding 20% shall be noted and fully explained. Implementation This policy will be implemented on all future cases and current administrative reviews and investigation where the information necessary to determine the diffmer and, if necessary to calculate constructed value exists and the change can be made without delaying the cases beyond their due dates.