Determining the principal function of multi-functional products
The UK Tribunal was recently faced with a dispute as to the correct customs classification of an Apple iPod Nano in the case of RMS Communications (TC00681).
The case centred round whether the iPod Nano should be classified under Tariff Heading 8519 (Sound recording or sound reproducing apparatus) attracting 2% import duty (as argued by RMS Communications) or 8521 (Video recording or reproducing apparatus, whether or not incorporating a video tuner) attracting 13.9% duty (as argued by HMRC).
The Customs Tariff contains circa 16,000 Commodity Codes. The correct classification of imported goods should be effected using the General Rules of Interpretation (GIR). The GIR have a cascading effect, so for example, if you are unable to classify a product after looking at Rule 1, then you move down the rules although Rule 6 should be used alongside Rule 1. Rule 1 provides that classification (whether it is 1 or 2 competing codes) requires an examination of the section and Chapter Notes and in the case of 2 competing codes, if it is still not possible to classify the product, then it is necessary to move to Rule 3. 1
In this particular case, the parties agreed that the iPod Nano was capable of both sound and video reproduction. However, the dispute arose because:
- HMRC argued that the iPod did not have a principle or primary function and that it was equally capable of both audio and video transmission whereas;
- RMS argued that the device was principally an MP3 player with a small video accessory as an “added bonus”.
The Tribunal was therefore faced with the two questions:
Does the Nano have a principal function?
If so, what is the principal function?
The Facts of the Case
RMS submitted a Binding Tariff Information application to HMRC in February 2008 arguing that the iPod Nano should be classified to CN code 85188.8.131.52 (“Other sound recording apparatus” (2% duty)).
RMS pointed to an Irish BTI ruling that had been given to Apple Computer International as well as two Dutch rulings classifying a similar product to the same heading. However, HMRC responded with a BTI Ruling classifying the product to CN heading 8521.90.00.90 (“Other video recording equipment”) (13.9%). RMS applied for a Formal Departmental Review but that review upheld the original BTI ruling.
HMRC submitted that if the Tribunal found that the iPod Nano did indeed have a “principal function” then the product should be classified according to that function is accordance with Note 3, Section XVI. However, HMRC argued that neither of the functions was a principal function and the product should be classified under General Rule 3© (classification under the tariff heading appearing last in numerical order). It supported this line with the following arguments:
Function: They argued that the correct test was to look at the products principal function rather than its principal use.
Objectivity at time of import: It argued that evidence of customer use was not relevant because at the time of import it was unclear to what purpose the goods would be placed.
Marketing: HMRC argued that Apple marketed the Nano as a “multi-functional” product as did distributors such as “Amazon” and they placed a great deal of emphasis on the fact that the Nano provided video technology as well as audio capabilities.
BTI only binding upon the holder: HMRC contended that the Irish and Dutch BTI’s were only binding upon the holder of the ruling and they were thus not bound to follow the rulings given in them.
RMS countered the above arguments using the following:
Intended use: The intended use of a product may constitute an objective criterion for classification of the product if it is inherent to it as long as the inherent character is capable of being assessed on the basis of the products objective characteristics and properties. Evidence of consumer use of the Nano was also relevant and this had been used in at least 3 cases before the ECJ (Sony, Neckermann and Thyssen). RMS submitted that the vast majority of independent third-parties would describe the Nano as an audio device.
Functionality: The audio function of the Nano made it the market leader. The present Nano was an evolution of the first and second generation Nano (that were classified under 8519). The small screen size was not to be used for watching film or TV programmes at length, the limited memory was far more detrimental to the video function than the audio one (i.e. if it was intended to be used equally there would be a bigger memory) and whereas it is possible to transfer any CD into “iTunes” and then onto the Nano, it is not possible to do the same with DVD’s.
Marketing: The marketing of the Nano did not imply that the main function of the product has changed but merely that the video was an accessory to the main function. In essence, the marketing used to promote the video function was “marketing hype”.
The Tribunal rejected HMRC’s assertion that it was the function of the product rather than the use that was relevant. It found that marketing or intended use may be determinative if it was ascertainable form the objective characteristics of the product and not dependent on subjective intention.
The Tribunal examined the characteristics of the Nano and made the following observations:
The design and size: The size and design of the Nano means that it is more suitable for its audio function than its video one. Its small size means that it is easily portable and the fact that the screen size was only two inches made it realistically unsuitable for watching video on a prolonged basis.
The memory: The Nano’s memory (4GB or 8GB) allows it to store either 1,000 or 2,000 songs (the equivalent to over 33 or 66 hours of music). However, in comparison it can only store up to 4 or 8 hours of video (and then only if the memory was wholly used for video.) Therefore the limited memory was far more detrimental to the video function than it was to the Nano’s audio function.
Furthermore, a more conventional video device mentioned in Commission Regulation 1056/2006 has a 30GB storage capacity and the ability to store 120 hours of digital video.
Compatibility: Whereas it is possible to transfer any CD into “iTunes” and then onto the Nano, it is not possible to do the same with DVDs. This makes it impossible therefore to watch DVDs on the Nano without converting the DVDs to a different format first, which will take time, and using third party software, will come at an additional cost.
The principal function
The Tribunal stated that the test to determine the principal function (if there indeed was one) was to consider which function would, if removed, most impact upon the functional utility of the device? Removal of the audio function would render the Nano a “flawed device” with a screen size, design, video, compatibility and memory inadequate for proper use. By contrast, removal of the video function would not have such a significant impact on the Nano especially bearing in mind that the first and second generation did not have video capability.
The Tribunal therefore ruled that the correct classification for the Nano was indeed 8519 rather than 8521.
This case once again highlights the potential difficulties of classifying a dual or multi-purpose product.
It is a little disappointing that a Departmental Review categorically agreed with the original Binding Tariff Ruling and this would suggest that there are flaws with the present system. There is sufficient precedence in case-law to enable identification of a “principal function” of a product by a variety of methods and when they are all applied in the present scenario. The key test pointed to the fact that the principal function of a Nano is indeed its audio function. Quite simply if you removed the audio function, you are pretty much left with a useless product. Furthermore, it is interesting to note that HMRC explained the original BTI as having been achieved following rules 1 and 6 of the GIR but during the actual proceedings referred to GIR 3© rather than 1 or 6.
HMRC is in between a rock and a hard place. With extremely stretched resources, HMRC is being expected to “do more with less”. The job of HMRC is to collect revenue and in cases where two codes are competing against each other, we would suggest HMRC will plump for the one that attracts more duty or face the possible wrath of the EU. Realistically, the chances of a Departmental Review overruling a classification expert are slim it is often better for an importer to elect to skip the Departmental Review stage and go straight to tribunal.
1 “3. Unless the context otherwise requires, composite machines consisting of two or more machines fitted together to form a whole and other machines designed for the purpose of performing two or more complementary or alternative functions are to be classified as if consisting only of that component or as being that machine which performs the principal function.”