On February 11, 2026, Applied Materials, Inc. entered into a settlement agreement for a civil monetary penalty of over $252 million with the U.S. Department of Commerce, Bureau of Industry and Security (BIS) for 56 unlawful reexports of semiconductor manufacturing equipment (SME), valued at approximately $126 million, to Semiconductor Manufacturing International Corporation (SMIC) in China, a party on the BIS Entity List.
The penalty is the statutory maximum and is the second-highest in BIS history. As part of the settlement, Applied Materials must also conduct two internal audits of its export compliance program and will be subject to a three-year suspended denial order that could be activated in the event of noncompliance with the terms of the settlement agreement.
This enforcement action offers several important lessons for companies navigating complex export control rules. Key insights include:
- BIS rejects “substantial transformation” as a determinative test for EAR jurisdiction, signaling that overseas assembly and testing alone may be insufficient to render an item foreign origin if U.S. content remains predominant.
- Heightened enforcement risk exists when policy concerns are clear, even if actions appear legally defensible; particularly where U.S. agencies have provided specific warnings.
- China‑related semiconductor transactions remain a top BIS enforcement priority, with export control rules providing broad U.S. jurisdiction over foreign‑based activities.
Background
Applied Materials is a U.S. manufacturer of SME. SMIC is China’s leading semiconductor foundry and was reportedly one of Applied Materials’ most important customers.
In September 2020, BIS issued Applied Materials an “is-informed” letter requiring Applied Materials to obtain a license for exports, reexports, and transfers (in-country) of certain items subject to the EAR to SMIC. In December 2020, SMIC was designated on the BIS Entity List due to alleged links between SMIC and the Chinese military industrial complex. The Entity List designation imposed a license requirement for exports, reexports, or transfers (in-country) of all items subject to the Export Administration Regulations (EAR) to SMIC or where SMIC was a party to a transaction.
For purposes of the Entity List restrictions applicable to SMIC at the time, items subject to the EAR consisted of: (i) items when exported from the United States, (ii) U.S.-origin items, wherever located, and (iii) items produced outside the United States with more than de minimis (in this case, 25 percent) controlled U.S.-origin content. (Following the conduct at issue in this case, BIS expanded the jurisdictional reach of the EAR by adding a new “Foreign Direct Product Rule” to the EAR, asserting jurisdiction over shipments involving SMIC of certain foreign-produced SME that is the product of certain U.S. software or technology or of equipment that is the product of certain U.S. software or technology).
In order to continue selling to SMIC despite the restrictions of the “is informed” letter and Entity List, Applied Materials offshored certain production activities for SMIC orders to its subsidiaries in South Korea. Under the arrangement, Applied Materials partially produced certain equipment in the United States, exported that equipment to South Korea for final assembly and testing, and then reexported the SME from South Korea to SMIC in China. Applied Materials had believed that this arrangement caused the items to be not “subject to the EAR” and therefore not subject to the relevant restrictions. Specifically, Applied Materials believed that this arrangement rendered the SME foreign origin, and not subject to the EAR because it contained less than de minimis controlled U.S.-origin content.
However, BIS disagreed and determined that the SME shipped to SMIC from South Korea remained U.S. origin and was therefore subject to the EAR and constituted a violation of the Entity List restrictions.
BIS Casts Doubt on 'Substantial Transformation' Test
In reaching its determination that Applied Materials violated the EAR, BIS determined that the SME reexported to SMIC from South Korea was U.S. origin and therefore remained subject to the EAR, despite the assembly and testing steps in South Korea.
“U.S. origin” is not defined in the EAR, and neither is the term “foreign made.” In the absence of a definition, Applied Materials assessed whether the SME assembled in South Korea would be U.S. origin based on the “substantial transformation” test. This test does not appear in the EAR, but it is widely used under U.S. and foreign customs laws to determine country of origin for purposes of tariffs, duty payments, and government procurement preferences, among other purposes. BIS indicates that Applied Materials adopted a variety of procedures to ensure that SME supplied to SMIC met its internal substantial transformation test criteria, and that its test was heavily reliant on the number of man-hours deployed in South Korea to assemble the components exported from the United States.
BIS expressly rejected that test, stating that it “is not the correct test for determining whether an item is subject to the EAR because it is an item of U.S. origin . . . [and that it] is a concept under the Customs regulations [] nowhere included in the EAR.” In its penalty discussion, BIS did not establish a clear test for establishing whether an item is U.S. or foreign origin for purposes of the EAR. But the agency did provide an explanation for why it considered the SME reexported from South Korea to be U.S. origin in this case:
“BIS deems that U.S.-origin items or items physically located in the United States on which production begins in the United States are not rendered ‘foreign-made’ when the items are exported and then undergo further assembly and testing in a foreign country when, as here, those activities outside the United States involved little or no foreign-origin parts that were shipped to the foreign location from a non-U.S. location.”
BIS does not provide guidance on how much foreign input or further processing would render an item foreign origin for purposes of the EAR. But, in this case, BIS indicates that there was insufficient incorporation of U.S.-origin inputs into a new foreign-made item for the SME to be considered foreign origin, noting that the de minimis test only applies when U.S.-origin items have been physically incorporated into a foreign item:
“What occurred in South Korea can be described as the combination of U.S.-origin and non-U.S.-origin content typically sent from the United States and assembled into already partially assembled U.S.-origin items, with little or no content sourced from outside the U.S. with which the U.S.-origin content was incorporated, and so no foreign-made item resulted.”
Applied Materials’ reliance on a substantial transformation test, that was itself heavily reliant on the number of man-hours deployed in South Korea to complete assembly and production, was insufficient in BIS’ opinion to render the U.S.-origin modules "incorporated" into a new foreign-origin item. As a result, BIS found that the SME reexported from South Korea remained U.S. origin and subject to the EAR. BIS did not address whether the assembly and testing steps that occurred in South Korea would be sufficient to satisfy the substantial transformation test articulated by U.S. Customs and Border Protection (CBP), which requires a fundamental change in the form, character, appearance, or nature of an item. A substantial transformation is more likely to occur where there is a significant change in value in the goods following production, but CBP is generally skeptical that mere assembly results in a substantial transformation where the essential character of the item existed before assembly.
Takeaways for Industry
The Applied Materials enforcement provides insight to industry in terms of how BIS views the jurisdictional status of items produced with cross-border production inputs and its continued focus on keeping SME out of the hands of sensitive Chinese counterparties.
- “Substantial transformation” does not provide full assurance that an item will be considered foreign origin for purposes of the EAR. Even where a producer determines that an item is foreign origin as a result of being substantially transformed outside of the United States, BIS has signaled that it is willing to find that such item is U.S. origin for purposes of the EAR if U.S. origin items are insufficiently incorporated into foreign-origin items. In particular, mere overseas assembly and testing is insufficient to render U.S. origin content “incorporated” for de minimis purposes.
- Exporters should be cautious when taking actions that they believe are legally defensible, but where the U.S. government has indicated a strong policy interest in preventing the conduct at issue. In this case, Applied Materials received an is-informed letter before the application of the general Entity List restrictions, indicating U.S. government concerns specific to Applied Materials’ equipment, and the company had license requests with BIS to supply SMIC that remained pending and under review. These factors indicate heightened enforcement risk, particularly in light of the U.S. government’s substantial foreign policy and national security concerns regarding the semiconductor supply chain in China. The enforcement risk was further heightened here because the company relied on a test that was absent from the regulations, and on which BIS has provided very limited public guidance in the past. Although the substantial transformation test was widely adopted by industry to determine origin status for purposes of EAR compliance, the lack of an explicit rule provided BIS with enforcement discretion to assert jurisdiction and violations of the EAR.
- BIS has focused enforcement efforts on activity involving China, Entity List parties, and microelectronics and semiconductors (e.g., Seagate, Cadence, and Alpha and Omega Semiconductor). The U.S. government has demonstrated that it will continue to assert U.S. jurisdiction to foreign business activity, and industry should proceed with caution with any activity involving Entity List parties.