Thursday, June 21, 2012

Minimizing your Tax Liabilities in China

China is and will continue to be one of the most attractive markets for consumer goods.  With a population of more than one and a half billion people and a middle class of more than 300 million, that is projected to grow to at least 700 million in the next 20 years.  Based upon our experience in China and having been a part of the tremendous growth, we have seen that this emerging middle class, which is already larger than the U.S. population, is spending money like crazy and is not saving like previous generations.

Given that China is one of the only places in the world that has had double digit growth in GDP (except for this year which is still 8%), it has a burgeoning and spend crazy middle class, a developing legal system and excellent infrastructure, everyone should want to bring their products and services into this market.  It’s not that easy.  For many products, and services there are taxes.  China does not have a national sales tax on retail items like other countries and so it imposes import duties, value added taxes and consumption taxes which the importer, wholesaler or retailer must add to the price the consumer pays.  It’s all hidden, but, believe me they can be quite steep.  For example, the total duty on imported wine, which is the only wine worth drinking in China, is between 41 and 50% which can make many products cost prohibitive when compared to quality – the value is just not there.
And people think China is cheap!

I would offer that in the major cities in China, cost of living is higher than most cities in the U.S. and Europe and inflation has not stopped in the 10 years that we have been advising clients in China.  China aint cheap anymore, but, the domestic market where they don’t mind paying higher prices on quality items (that aren’t fake) is enormous and growing.

So, until the central government decides to either scrap it’s antiquated and cumbersome Value Added Tax “V.A.T.” system, which we don’t see that happening for a long time as too many people would lose a lot of money, or they lower the import duties and consumption taxes on imported products – there might be other ways to import products that are in high demand in China.

China and Hong Kong operate under a one country two systems arrangement that has been in place since the turnover in 1999.  Despite obvious cultural differences and the fact that there is a border crossing, most of us who do business in South China consider the two as one.  In fact, there is a treaty between Hong Kong and China which many people don’t know about that allows for Hong Kong companies and professionals to operate in China and also a few other things such as the duty free import of Hong Kong made products.  Below is a summary of the CEPA rules pertaining to importation of Hong Kong products which could provide a solution to the high import duties in China.
In order to enjoy zero tariffs under the Closer Economic Partnership Agreement (CEPA), goods exported from Hong Kong to Mainland China must fulfill the rules of origin and show evidence of being “made in Hong Kong.”

The execution of the rules of origin is detailed in the “Customs Provisions of the People’s Republic of China on Executing the Rules of Origin for Trade in Goods under the Mainland/Hong Kong Closer Economic Partnership Arrangement (haiguanshuling No.106, hereinafter refers as ‘Provisions’),” which was promulgated in December 2003 and came in effect from January 1, 2004. Under the Provisions, “Hong Kong” as the origin of goods shall be determined according to the following principles:

  1. Goods entirely obtained in Hong Kong; and 
  2. Goods “substantially manufactured” in Hong Kong if not entirely obtained in Hong Kong Goods entirely obtained in Hong Kong According to the Provisions, goods entirely obtained in Hong Kong include:
  • Minerals exploited or extracted in Hong Kong
  • Plants or related products collected in Hong Kong
  • Animals born and raised up in Hong Kong and their related products
  • Animals hunted in Hong Kong
  • Fish and other sea products caught by ships with Hong Kong licenses and regional flags and their related products
  • Waste disposal for recycling from and collected in Hong Kong
  • Waste and scrap for recycling resulting from manufacturing in Hong Kong
  • Products made out of waste disposal or waste and scrap mentioned above Substantial processing, transformation, or manufacturing The criteria of determining whether the products are “substantially manufactured, transformed, or processed” in Hong Kong should include the following:
Manufacturing or processing operations.  The goods should be endowed with essential characteristics after principal manufacturing or processing operations in Hong Kong.
Change of tariff number.  Change of tariff number refers to a change of the four-digit tariff numbers and taxation categories after the manufacturing or processing operation of non-Hong Kong materials in Hong Kong. Moreover, no further manufacturing or processing should happen outside Hong Kong.
Ad valorem percentage.  Ad valorem percentage is the ratio between the total value of raw materials, components, labor and product development that are fully acquired in Hong Kong, and the FOB value of the finished product for export.
  • Ad valorem percentage = (Value of raw materials + value of components + labor costs + product development costs) ÷ (FOB value of finished product for export) Products with an ad valorem percentage equal to or greater than 30 percent, and with the last manufacturing or processing procedures completed in Hong Kong, shall be regarded as “substantial processing.” The following stipulations apply:
    • Calculation of the above “ad valorem percentage” should be consistent with generally accepted accounting standards and with the “Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.”
    • “Product development” refers to product development conducted in Hong Kong for the purposes of producing or processing the exporting goods. Incurred expenses for development shall be related to the exporting goods, including the costs for self-developing of the producers and processors, as well as the costs for the developing of consigned natural or legal person. The expenses also includes fees for purchasing designs, patents, patented technologies, trademarks or copyrights processed by a natural or legal person in Hong Kong. The concerned value should be clearly identifiable under generally accepted accounting standards and the provisions of “Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.”
    • If raw materials or components originating from Mainland China are used and they constitute part of the export products in Hong Kong, when calculating the ad valorem percentage of the export product, the raw materials or components from Mainland China should be deemed to be originating from Hong Kong. The ad valorem percentage of the export product should be greater than or equal to 30 percent, and greater than or equal to 15 percent excluding the price of the raw materials or components from mainland. Other criteria The “other criteria” refer to other criteria agreed by authorities of both Mainland China and Hong Kong in determining the origin of the products, besides the three above-mentioned criteria.
Mixed criteria. The “mixed criteria” means that two or more of the above-mentioned criteria are used in determining the origin of the products. Manufacturing or processing for the purpose of transporting or storing the goods, facilitating the packaging of the goods, or better packaging and displaying the goods is not considered as “substantial processing, transformation, or manufacturing.”
Simple diluting, blending, packaging, bottling, desiccation, assembling, sorting or decorating will not be regarded as “substantial processing, transformation, or manufacturing.”

Package, packaging materials, containers and accessories, spare parts, tools and explanatory materials accompanying the goods should be ignored in determining the origin of the goods.

by Frank Caruso
IPG is engaged in projects for companies and entrepreneurs doing business in Bangladesh, Cambodia, China, Korea, Laos, Myanmar, Vietnam and the U.S. _________

Monday, June 18, 2012

Protecting your Reputation in China: Copied Products

You know that I like to write about the various copied products that are made here in the Jungle.  I usually find things like copy salt and eggs to be humorous, but, in this case it is not funny as the lives of civilians and military personnel are on the line when counterfeit parts are sold to the U.S. and other armed forces.

After a year long investigation, where we advised the Senate Armed Services Committee on the real problem with counterfeit parts and the harsh reality of counterfeiting in China, the SASC released its report which you can find a synopsis here with the full report being available on the SASC website soon.

While one of the objectives is to place the blame squarely on the counterfeiters in China, there is little legal recourse available and given that most companies that purchase electronic components from China know that many of the parts are counterfeit, they look the other way and pass the parts up the Defense Department supply chain.  Up until now, that hasn’t been much of an issue and the reward far outweighed the risk.

Of course cost is an issue when there are four or five companies involved in the supply chain and each one has to make some margin on the product.  However, an easy solution, to this problem, would be to ensure that the parts are inspected by a reputable third party electronic component inspector, such as the non-Chinese owned Whitehorse Laboratories who has been warning everyone of this problem for years and was also involved in advising the SASC on this matter.

As the Justice Department and various enforcement divisions of the Defense Department and Department of Homeland Security begin investigating defense contractors and component suppliers and this has already begun and will be ramped up considerably in the near future, the simple solution is to test the components and have agreements in English and Chinese with the Chinese suppliers that provides for recourse.

The penalties for supplying counterfeit parts are set forth in the recent National Defense Authorization Act which you can find a summary here and investigation and enforcement has begun.
While the SASC and the State Department will continue to pressure China to wipe out counterfeiters, it will not happen.  Counterfeiting and copying is woven into their DNA, especially in certain parts of Guangdong Province where even the late Chairman Mao had a difficult time trying to control the leaders who ruled this region.

So, what can you do so that your company will not be investigated and fined.
1.  Have a sample of the parts tested by an independent and professional laboratory.
2.  Purchase from reputable vendors in China and have written agreements with them which could be as simple as purchase order terms or terms of purchase on your website in English and Chinese.
3.  Keep records of the efforts you make to ensure that you are not passing on counterfeit parts.
4.  Don’t trust your Chinese employees to handle any of the above and if you do, supervise, supervise, supervise.
More on this as it develops.  Be vigilant.
IPG is engaged in projects for companies and entrepreneurs doing business in Bangladesh, Cambodia, China, Korea, Laos, Myanmar, the Philippines, Vietnam and the U.S.

Yachting Industry in China

I like to write about my clients who try.  Now, they don’t always succeed and when they don’t it is usually because they were too early or the market factors weren’t what they expected and a few other reasons, as believe me, they were prepared legally to enter the fray here in the Jungle.  It turns out that the clients of mine that are entrepreneurial, using their own money and taking their own risk are my favorites and they turn out to be some of my best friends.  I wrote about Jame Guo and Ben Hart on my blog a few years ago when they launched the first sailboat that they built in their factory north of Shenzhen.  I was honored to be invited to the launching and when they put the beautiful 48′ foot cruising sailboat in the water I was also very proud of them because it is difficult – extremely difficult.

Now, more than two years has passed and 8 sailboats have been delivered and are comfortably sailing the seas.  I had the opportunity to go on an afternoon sail on their brand new 52′ Farnova Catamaran this past weekend and once again I was honored to be included and equally proud of my friends and clients.  Now, I prefer mono-hull sailboats because it just feels more like sailing, this new Catamaran was just about the most comfortable sailing yacht I have ever been on.

While it’s not easy to build a shipyard from scratch and begin making insurable and sea worthy vessels that people want to pay lots of money for – Ben and Jame at Farnova have pulled it off.  Not only are they making beautiful sailboats, but they recognize that the domestic market in China will continue to grow and the Chinese consumers will purchase more sailing yachts.  Congratulations to Farnova and we are happy to have you as a client.

By Frank Caruso, Chair of the China Practice Team at IPG.
IPG is engaged in projects for companies and entrepreneurs doing business in Bangladesh, Cambodia, China, Korea, Laos, Myanmar, the Philippines, Vietnam and the U.S.