When it comes to selling your made in China product in the Chinese market, the process can be considerably more difficult than it seems initially. In the past couple of years, rising shipping costs, trade tensions and tariffs have forced foreign companies manufacturing their products in the country to consider selling them back to Chinese consumers.
Foreign companies, which have their products made under contract arrangements with Chinese manufacturers, do not own the item until after it is shipped outside China. For this reason, selling the product within China requires a complicated process of exporting out of the country and then importing back. This procedure may result in paying VAT twice: once on the export and again on the import.
There are Chinese companies that offer foreign buyers of contract manufactured products intricate deals to avoid double taxation. These partnerships are usually the wrong approach.
Often, a Chinese company will offer the foreign one a partnership or joint venture that will allow the foreign firm to participate in the product distribution business in China. Such commitment is usually a mistake, particularly when tax avoidance and “incentives” for making sales are the major objective.
The best route is to operate under the standard distribution model used throughout the world. In this case, the foreign company buys its products from its Chinese manufacturer, receives that product outside China (in an export processing zone or when shipped) and then sells it back to a qualified Chinese distributor, which can be in mainland China, in an export processing zone or in Hong Kong.
The foreign company should supervise the operations of the Chinese distributor through a standard distribution agreement. With this framework, the foreign company earns its profit from the initial sale, freeing it from any concerns with the financial side of the Chinese operation.
Under this agreement, the foreign company can terminate the relationship if the distributor does not perform, and it has the right to audit the distributor’s performance, as well as end the deal if the Chinese distributor engages in irregular conduct such as bribery or kickbacks (which is common).
The foreign company is free to offer the Chinese distributor incentives, such as not charging for product used as samples, reduced pricing for a certain number of products, and incentive payments for advertising, seminars and/or covering the cost of government registrations.
A major challenge in any kind of partnership/joint venture (JV) approach is that it is difficult to hold the Chinese side to a certain performance standard when there is a business ownership relationship.
Generally, to export and import back a product into China, the local distributor will have an entity in Hong Kong. The foreign company can take an ownership interest in the Hong Kong distributor, but should treated it as a third party, operating under a standard distribution agreement, and it should earn profits from sales to the distributor, cashing them immediately and not from the tax-disadvantaged distribution of profits at some uncertain later date.
In many cases, multinationals believe that creating a joint venture with a Chinese distributor will give them more control. Unfortunately, making quick decisions and controlling the operations of a JV thousands of miles away is almost impossible.
China tends to be a complex market and getting involved in product distribution without the proper experience can be extremely difficult. For this reason, international companies trust this part of the job to expert Chinese distributors.
Smaller enterprises and start-ups with no experience in distribution are regularly approached by Chinese companies with this kind of ill-conceived concept.
However, if your company has a product made in China and is approached to sell that product through a joint venture scheme, there are a few rules of thumb you can follow.
First, if the proposal is complex, don’t do it. You should be able to understand every word of the proposal in a first reading.
Second, if the proposal involves an equity joint venture business, don’t do it. Do not get into any business relationship with an entity in China that you cannot terminate by a simple contract termination notice.
Third and last, if the proposal is not supported with a detailed set of financial projections, don’t do it. A “business plan” full of concepts and analysis no one really understands does not count. You need a standard set of financial projections (hard numbers) with each assumption clearly spelled out and supported with facts.
Following these basic steps will help you understand better the process and will save you a significant amount of time and money.
Another important step you can take is to vet your distributors. Find out who they are, ask to speak to their clients and verify their information. Make sure the information they give you is real (such as their address). Simple common-sense steps can help you understand who you are dealing with and if this person or entity can be trusted.
Last but not least, this may be the trigger you need to decide whether to establish your own entity in China, which then buys and sells the goods on its own, without using a Chinese distributor or partner.
For more information on the options available, do not hesitate to reach out.
To learn more about our services in China, contact our Head of Business Advisory - Ms. Kristina Koehler-Coluccia at kristina@woodburnglobal.com.
DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.