Where does a software product originate?

Peckinpaugh is a member of the government contracts section of the law firm Winston & Strawn, Washington, D.C.A contractor raised the following topic: How do the country-of-origin rules that cover government contracting apply to computer software?

In government procurements, the determination of a product's "country of origin" is very important. Under the Buy American Act, agencies give preference to items manufactured in the United States from components that are at least 50 percent domestic— called "domestic end items." Furthermore, under the Trade Agreements Act, agencies may be forbidden from acquiring foreign items unless the items have been "substantially tranformed" in a designated country. These items are called "designated-country end products."

The application of these rules to manufactured goods is relatively straightforward. However, the rules are not as easy to apply to less tangible items such as software.

Frequently, the courts will examine general foreign-trade laws when government contracts precedents are unavailable. For most purposes, it appears that a software product's country of origin is the country in which the software was loaded onto the medium that is used to transfer the product to the purchaser. For example, under the Tariff Act of 1930 (19 U.S.C. : 1304), most articles of foreign origin imported into the United States must be marked with the English name of the country in which the article underwent its last "substantial transformation."

In Ruling HQ 732087 (Feb. 7, 1990), the Customs Service determined that "the writing of a program onto a computer diskette is a substantial transformation of the diskette. Although the name of the article remains the same, the adjectives applied before and after processing, i.e., blank and programmed, indicate that the articles are no longer interchangeable. The character of the diskette has changed from one of a blank storage medium to one with a predetermined electronic pattern encoded onto it. Also, the use of the diskette has changed from that of an unreadable, therefore meaningless, article of software, to that of an encoded instruction guide to enable a computer to perform various commands."

Moreover, under the Harmonized Tariff System of the United States, most software is classified under Subheading 8524.90.40. Note 6 to Chapter 85 of the HTSUS states that "records, tapes and other media of Heading 8523 or 8524 remain classified in those subheadings, whether or not they are entered with the apparatus for which they are intended." This rule extends even to software that is permanently installed on the device with which it is used. [See, for example, Customs Service Ruling HQ 950675 (Jan. 7, 1992). Software used with equipment to measure electrical currents in a patient's heart should be classified under Heading 8524 whether imported in floppy disk form or downloaded onto the system's hard drive.]

In a somewhat different context, in Ruling HQ 545279 (Nov. 30, 1994), the Customs Service discussed the use of software "masters." In that case, a buyer was purchasing for resale in the United States foreign electronic game cartridges, which consisted of read-only memory integrated circuits that were soldered to printed circuit boards and enclosed in plastic housings. The buyer engaged independent contractors to provide the coding services.

The resulting code was provided to the buyer in the form of a floppy disk or by electronic transmission. The buyer would transfer the code to an erasable programmable ROM chip, which it sent to an overseas manufacturer at no charge. The manufacturer used the EPROM to create a photo-mask, which reproduced the programming pattern. The pattern was then transferred to silicon wafers, and the wafers were used to make the ROMs.

According to the Customs Service, the coding services were similar to detailed specifications, the provision of which to a manufacturer constitutes an "assist." Such an assist must be included in determining the value of the imported product for calculating the applicable tariffs. According to the Customs Service, "Although in the instant case the format of the coding undergoes changes (from floppy disk, to EPROM, to photomask, to silicon wafers, to ROM), these changes do not alter the code or program itself. The code is embodied in the ROM which is a component of the imported video game." [See also Customs Service Ruling HQ 545256 (Jan. 10, 1995).]

"While the use of EPROMs is an efficient and cost-effective method of transferring the U.S. software, given the variety of alternatives available, the actual method of transfer appears to be immaterial. For Customs' purposes, however, what is important is that the buyer supplies U.S. software, free of charge, for use in the production or sale of the imported [devices] in the United States."

However, in RG Software Systems Inc., SIZ-95-5-23-53 (Oct. 30, 1995), the Small Business Administration found that a U.S. subsidiary of a foreign company was the manufacturer of anti-virus software purchased under a contract that had been set aside for small businesses because it "combines the basic program code with other essential components to produce the end product required by the solicitation." The domestic subsidiary "adds hypertext files that create functions to generate the necessary help," which "are all essential to the final product."

Its "efforts constitute a significant contribution to the end item, without which the software could not satisfy the requirements of the solicitation." Thus, the SBA focused mostly on the underlying software development. It did not address the loading of the software onto a medium.

In the past decade, American companies have relied heavily on foreign organizations to perform software development services.

As more software coding work is performed overseas, it is likely that country-of-origin issues for software products will become more important and more well-defined. In the meantime, companies for which this issue is important should analyze them carefully.