American Companies Selling to China – Why and How

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Impressive increases in exports drive U.S. businesses to export to China. This is a user’s guide on joining the trend – and includes a complimentary U.S. Dept. of Commerce download

Op-Ed Commentary: Chris Devonshire-Ellis, Founding Partner of Dezan Shira & Associates

Mar. 28 – With the U.S.-China Business Council poised to release a report outlining significant gains in U.S. exports to China over the past 12 months, the opportunities for American companies to sell goods and services to China has never looked brighter. Part of this is a significant and still growing shift concerning China’s own dynamics and demographics – a phenomenon we covered earlier this week in the piece titled “Why China’s Consumer Development is Assured.” Put simply, the article explains that when China began its policy of opening up to foreign investment 25 years ago, it had no developed middle class and there was simply no meaningful Chinese wealth to buy American goods and services.

Today, the emergence of a significant Chinese middle class – thought to number some 250 million – is changing the needs of China and finally enhancing the sales opportunities that foreign businesses now have in selling to the Chinese consumer. This is borne out by the latest U.S.-China trade figures, which are expected to show that U.S. exports to China have exceeded US$100 billion in 2011 for the first time, and is a demographic trend likely to continue for at least the next two decades onwards.

It is also on an upward curve – China’s middle class population is set to accelerate and is expected to double to 500 million by 2020. Clearly, now is the time to drop perceptions of China as purely a destination for the manufacturing of cheap goods and to start appreciating it as a huge consumer market.

This article, as a general guideline, provides some basic advice and information as to the initial steps that should be taken by any internationally-minded company now looking to take advantage of the new China dynamic; that being a consumer market both willing and able to buy American goods and services.

Intellectual Property
This remains one of the foremost concerns of many global investors looking at the China market. It can be broken down into three sections:

  • Trademarks
  • Patents
  • Technology transfer

Trademarks
The Chinese penchant for concentrating on ripping off brands has diminished in recent years, mainly as the perceived value, with a very few high profile cases (such as Apple’s iPad), has been superseded by a desire to obtain more valuable technology and innovations. Consequently, the extent of being exposed to brand theft is lessening. However, that does not mean that this no longer remains a risk, because it does, and it is exhausting and frustrating should it occur. We recently provided advice on this subject in this piece: “Planning your Trademark Strategy for China” and we recommend following the content as a guide.

Patents
This is a more serious issue and could be, in some instances, a deal-breaker for entering the Chinese market. A lot of the issues relating to trademarks (above) are similar for patents, however at stake is a far more valuable asset. Our firm has produced a technical guide concerning IP laws in China and the filing of patents – we recommend this as a reference of first resort. Our practice does not handle patent filings, but we do instead recommend discussing this subject with a specialist patent law firm in China. We can make introductions upon request.

Technology transfer
This seemingly innocuous phrase is often built into contracts with Chinese suppliers, vendors and especially joint ventures. Be very aware that this can manifest itself for the unwary as a means to obtain your most valuable assets – which can include patents and other highly strategic and valuable innovations – for nothing. Take extra care when dealing with this issue and engage experienced counsel to advice. Our IP book (referred to above) deals with this subject, as does our technical guide “Setting Up Joint Ventures in China.” Do not be convinced to give up what may be a prize asset under the guise of “technology transfer” contributions in return for a deal. As soon as you have parted with your technological contribution, you run the risk of being unceremoniously dumped.

Selling to China
This rather broad issue can in fact be relatively easily divided into two parts in terms of market access. Firstly, are your Chinese buyers willing and able to continuously pay for your product and services in U.S. dollars? If so, then there’s possibly no need for you to set up a legal entity in China. That’s the good news – everything can be conducted contractually, which costs less in terms of investment (but make sure you still obtain good China-sourced legal advice over the contractual terms). However, what many overseas businesses wishing to sell to Chinese companies don’t recognize is the difficulty that Chinese companies face in getting you your U.S. dollars. It is an issue for them, and this is why:

The RMB is not a fully convertible currency
You’re in the United States and want to be paid in U.S. dollars. But your Chinese buyer trades in RMB. To meet your U.S. dollar invoice, he must take the following steps:

  1. Submission of your invoice for withholding tax assessment. This applies to services, but typically amounts to an invoice deductible amount of 8 percent to 20 percent of the invoice value, depending upon the service rendered. You need to know what this amount is.
  2. The Chinese company pays this money and deducts it from your invoice. A tax paid receipt is then given.
  3. The Chinese buyer takes that receipt to the State Administration of Foreign Exchange (SAFE) to obtain permission to convert his RMB into U.S. dollars to meet your remaining invoice amount.
  4. He takes that to his bank and they wire the money to you.

As can be seen, just getting paid from China is a time-consuming and lengthy process and is open to a hefty excuse for extending way beyond your agreed credit terms.

U.S.–China double tax treaties
As we’ve discussed, getting paid can involve the deduction of tax from your invoice. Although in the United States, various claw-backs can be initiated through the array of double tax agreements the country has with China. To understand exactly what your potential liability is, and how to mitigate part of that against the applicable treaty is a tax matter and should be fully understood prior to any sales being made. Here, our firm can assist as we are both tax consultants and also have a liaison office in the United States. Advice should be taken in advance in terms of how your sale to China may be affected by tax treatments.

In any event, many U.S. businesses will find that in order to get around the scenario above, it makes better commercial sense to establish their own operations in China purely to permit local companies to pay you in RMB without the need to go through the tax and SAFE administration. A critical mass is often reached where setting up a China based entity becomes economically viable in order to continue to expand and develop your China sales capacity.

Legal Structures
There are two essential types of legal structures for foreign companies to use, being either a liaison (representative) office or a LLC. The differences between them are simple – a representative office cannot invoice (although it may carry out marketing and other sales facilitation services) while a Chinese LLC can. China’s LLCs take various forms in foreign investment, briefly as follows:

Foreign Invested Commercial Enterprises (FICE)
These are typically used for trading, franchising and import-export businesses, including most sales operations. They are not used for manufacturing. Consequently, the registered capital requirements are relatively low and they can also be used to invoice local customers in RMB. Corporate income tax applies to profits of course, as do a number of other taxes and considerations, however for many this would be an ideal, low-cost structure to use as they also permit 100 percent foreign ownership. FICE are a type of WFOE and are discussed in great detail in our technical guide “Setting Up Wholly Foreign-Owned Enterprises in China” as well as our July/August 2011 issue of China Briefing Magazine title, “Trading and the Rise of FICE.”

Wholly Foreign Owned Enterprise (WFOE)
WFOEs are used mainly for manufacturing, although they may also be used for trade, and in some instances, services, depending upon business scope and the extent of your activities in China. They are definitely useful if wishing to combine U.S. imported parts with China domestically sourced parts in order to provide an end-product made from both. Attention to detail needs to be paid to issues concerning value-added tax, customs duties and other tax considerations, again these are covered in detail in our technical guide on the subject which is now in its fourth edition. Profits tax and so on applies, so repatriation issues need to be fully understood.

Joint Venture (JV)
These are also LLCs, although include both a Chinese and a foreign partner. They may well be useful to gain some certainty of supply or manufacturing if part of that needs to be sourced from China. They may also be useful in securing parts of the supply and distribution chain. It is however a huge subject and we have written extensively about it in our technical guide on the subject titled “Setting Up Joint Ventures in China.” Joint ventures are nearly always unique animals, and best discussed in detail with legal and tax counsel in China well-versed in the subject. Our own firm has 20 years of experience in the matter.

Representative Office (RO)
These are not LLCs, but operate as a liaison office only between your U.S. parent and China. They may not invoice, however they can be used for marketing, sales facilitation, quality control work and on-going support roles for the China end of your business. Recent regulations have increased the tax liabilities of these entities, but nonetheless an RO can be a useful and relatively low-cost facility to have. Our technical guide on the subject, “Setting Up Representative Offices in China,” is now in its fourth edition and has long been our best-selling business title.

The subject of selling to China is of course a diverse and multi-faceted topic, with different scenarios and solutions applicable to almost each and every business type. In China, a cookie-cutter model does not apply and advice needs to be taken from experienced consultants with years of experience, including a proven track record on-the-ground in China. Fortunately, some advice is available gratis.

An excellent, complimentary beginners overview to conducting business in China may be obtained courtesy of the U.S. Commercial Service, whose “China Business Handbook” is now in its second edition and was co-written by our practice. It is available as a 60-page PDF here.

To summarize, the main two issues to consider when selling to China is firstly, how can your Chinese buyer pay you? Secondly, establishing operations in China (if necessary) is largely a tax-based question as opposed to a legal structure issue. The latter is relatively easy to solve and the real expertise comes with a true appreciation of the financial implications involved. Again, we have covered this in our well-received and easy-to-understand technical book titled, “The China Tax Guide.” Additionally, our firm’s 12 China offices can provide on-the-ground support to U.S. businesses In China.

The market demographics dictate that, finally, China is poised to develop as an exciting and productive market for American goods and services. This neatly puts the onus back on U.S. companies to do what traditionally they have always been best at – manufacturing great products and selling them. China increasingly represents a growing market for American and other businesses to participate in, and the time is now ripe to expand horizons and look overseas for growth in sales. Our practice not only has the necessary expertise, but also the well-received published intelligence and the on-the-ground intellect and personnel to assist American companies in the China market. We look forward to welcoming more U.S. corporations to China to take advantage of the new possibilities this dynamic country can now provide.

Chris Devonshire-Ellis is the founding partner of Dezan Shira & Associates. The practice has been advising international companies on China market entry, legal establishment, tax and on-going regulatory and compliance issues since 1992. The firm now has 12 China offices and is also in the United States. Please E-mail inquiries or questions to china@dezshira.com, visit the practice at www.dezshira.com, download their brochure here, or make direct contact with their U.S. liaison office by E-mailing jessica.tou@dezshira.com.

CHINA & EMERGING ASIA WEBINAR
Chris Devonshire-Ellis hosted a webinar in the United States recently on this topic, which included discussions about opportunities for U.S. and international companies in China, India, Vietnam and Emerging Asia, in addition to providing cost comparisons between them. It can be accessed here.

Related Reading

Doing Business in China
Our 156-page definitive guide to the fastest growing economy in the world, providing a thorough and in-depth analysis of China, its history, key demographics and overviews of the major cities, provinces and autonomous regions highlighting business opportunities and infrastructure in place in each region. A comprehensive guide to investing in China is also included with information on FDI trends, business establishment procedures, economic zone information, and labor and tax considerations.

The China Tax Guide (Fifth Edition)
This popular book, fully updated with all recent tax changes and amendments, details all taxes in China affecting businesses and individuals, how to calculate the amounts due, tax registration and filing procedures, tax minimization techniques, and claiming VAT rebates. It also details good financial management techniques, handling negotiations with the tax bureau and annual audit and compliance procedures.

Setting Up Representative Offices in China (Fourth Edition)
This is an essential, practical guide for any foreign enterprise or business-minded individual to understand the rules, regulations and management issues regarding establishing representative offices in China. This updated edition also includes detailed descriptions of the 2010 regulatory updates which have impacted on ROs.

Setting Up Wholly Foreign Owned Enterprises in China (Third Edition)
This guide provides a practical overview for any business-minded individual to understand the rules, regulations and management issues regarding establishing and running a WFOE in China.

Setting Up Joint Ventures in China (Third Edition)
This guide walks you through, step-by-step, each of the key points of setting up a joint venture in China. It includes a complete draft of both a JV contract and articles of association as well as an overview of JV laws, negotiation issues, land use rights, IP protection and technology transfer, in addition to tips on staff hiring and HR. It also describes tax and audit responsibilities in addition to buying out a JV partner and liquidating.

Intellectual Property Rights in China (Second Edition)
From covering protocol for dealing with trade fairs, to the application processes for trademarks, patents, copyright and licensing, as well as dealing with infringements and enforcement, this book is a practical reference for those concerned with their IPR in China.

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