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The Double Standard “Tax” On Foreign Companies Doing Business In China. What To Do?

Posted in China Business, Legal News

Just read a highly relevant post by Ben Shobert (it’s sheer coincidence that I am having lunch with him today) on The Ethical Challenges of Doing Business in China’s Healthcare Economy. Though Ben’s post focuses on health care companies, it applies to virtually all foreign companies doing business in China. Ben’s post stems from an MBA class he taught at the University of Washington.

At one point in the article, Ben states that the “larger question” is “whether the incrementally different standards they [foreign pharma companies in China] must hold themselves to represents what amounts to a tax — both because their host country will look first at foreign companies and hold them to higher standards, but also because the standards in their domestic markets (FCPA, UK Bribery Act, etc.) are applicable regardless of where they might do business.” That is not a question, it is a fact. Foreign companies doing business in China have always been and for the foreseeable future always will be held to a higher standard than Chinese domestic companies.

Back in 2011, we addressed this same question and emphatically came up with the same answer, in When Should You Deal With Your China Ethical Issues? Yesterday:

All but one of these are great questions. The only one I do not like is the next to the last one, “Are foreign companies held to a higher ethical standard in our industry than local companies? The only reason I do not like this question is because I am of the view that one need not even bother asking it because the answer will always be “yes.” In that same post,

Similarly, In The Painted Veil On China Law, we talked of how China law enforcement differs between foreign and domestic companies:

There is one law in China for Chinese companies and that law has little or nothing to do with you as a foreign company. There is another law in China for foreign companies and that law does apply to you.  The laws that do apply to you are likely not all that different from the laws that apply to you in your home country and you are no doubt used to following the laws there.  You should view China similarly.

I cannot resist citing to one of my all time favorite comments, left here by one of the writers (Pipi) of the late great Sinocidal blog, on the differences between foreign companies doing business in China and domestic companies doing business in China:

When in China, do as the law says, not as the Chinese do. The laws are not intended to be enforced fairly – they’re their to be interpreted and enforced as local government sees fit to protect their clan, kin and cash-cows.

Does anyone really think that foreign companies (or at least Western companies) do not have to be just a little bit better than their domestic companies to survive in China? To the extent this “need to do better” can be called a tax (and I most definitely think that is what it is), foreign companies face higher “taxes” in China than domestic companies. And foreign companies that do not engage in bribery and corruption in China are likely at a disadvantage as compared with their Chinese competitors that are more likely to use such methods. And foreign companies that do engage in bribery and corruption are at a disadvantage as compared with their Chinese competitors because they are much more likely to be prosecuted (in China and at home).

Ben’s more interesting question, and one that was addressed by Ben and his MBA class, is “for life science companies like GSK, what really are their options?

Ben and the class saw the following five options (my comments are in italics):

  1. You can choose to maintain western standards of compliance. “The implications of this are that your domestic competitors, and, it should be noted some of your less scrupulous foreign ones as well, will not hold to this approach. So, you cannot simply hold to a high standard, you have to put in place strong sales and marketing tactics that work to stay front of mind in the consumer and healthcare professional.  But, in an emerging economy such as China’s, is this even a realistic strategy? Do consumers have enough discretionary income that they can realistically value the intangibles your therapy is going to offer, or is the decision the consumer will make no different than that the doctor or hospital administrator is going to? If your product is positioned based on an economic rationale that is inconsistent with that of your market, can you compete?”  Right, but you have failed to address a much bigger question: are you willing to risk jail time and public humiliation and reputational damage by engaging in bribery/corruption?
  2. Hold to the status quo. “Here’s what that means:  essentially, you assume the crack down is short-term, and inherently political in nature. ‘This too shall pass’ becomes the phrase you hear executives saying just under their breath as they count rosary beads during weekly management calls. If you believe that the crackdown on GSK was largely a political move by Beijing to accomplish two goals – lower prices and divert the public’s attention away from the government’s own culpability in the dismal state of China’s healthcare system – then you might take the slap on the wrist and move on. Companies that make this bet likely believe that the rules in China are not really in flux; that in twelve months practices in China’s sales channel will look basically like they did twelve months before the GSK scandal. Implicit in this conclusion is that China’s decision is inherently political, and companies who hold to this view would do well to remember that future responses to crises along lines of affordability and access are going to result in similar actions towards foreign companies.”
  3. Fundamentally change your sales strategy.  “This assumes the sort of tactical re-arrangement of how you sell and market like was mentioned earlier, but it also forces companies to bring newer drugs to China earlier than they had originally planned.  For most of the last three decades, products brought into China from all sorts of sectors have tended to be more mature. Much of this has to do with the China market’s inherent IP issues, but also the sense that Chinese consumers were not ready for the more current products. Pharma has been no different, but this approach might have to change for companies that now feel they have no choice but to accelerate their product life cycle plans that originally called for more mature products to migrate to China in an effort to hold off the anticipated IP and price pressures more sophisticated therapies would encounter.”
  4. Exit China. ”Don’t laugh. The world’s second largest generic pharmaceutical company, Actavis, just did. My most recent Forbes column touched on this, and made an effort to remind people that there are multiple reasons for Actavis to have left, and that the company’s timing may be designed to take advantage of a moment when they could leave China without questions being asked about why they were not further into the Chinese market versus their competitors. GSK threatened to leave China if the fine from the Chinese authorities was too large, a threat the CEO quickly rescinded. But, neither company would be the first to come to the conclusion that they could not operate successfully in China and that they needed to deploy capital elsewhere.”
  5. Mitigate compliance risk through a very strategic use of distributors. “At its worst, this approach is designed to hide non-compliant behaviors from auditors; at its best, using good distributors is a strategy that forces compliant behaviors into parts of the supply chain that previously were not visible to manufacturers. Typically this involves competent distributors taking over, or managing, the efforts of small dealer networks around China that had previously little to no supervision, simply because of the highly fragmented nature of the dealer networks that service China’s hospitals.”

This is one of those situations where being a China lawyer is much easier than being a manager of a foreign company doing business in China. When my clients ask about how they should handle corruption in China, I tell them that they must never engage in it and that they need clear policies and training sessions to make crystal clear to their own people that corruption simply will not be tolerated. I then tell them that if they do not have a corruption plan AND a corruption policy in place, they have increased their chances of being in a world of pain at some point. I then usually put it to them directly: which of the following do you want to be able to say to the Chinese authorities/US federal prosecutors if your company is ever accused of having engaged in corruption?

  • Oh, sorry, I didn’t realize that corruption might be a problem.
  • We did everything we could to try to prevent this. Here is our policy manual which we require our employees to sign when they join our company and re-sign to acknowledge every year thereafter. And here is a record of the full day mandatory anti-corruption training we give to our employees every six months and the written materials we provide to them each time.  As you can see, the employees implicated in this case each attended x number of these sessions. I really do think we did everything we could do as a company to try to stop this sort of thing and I think you will find that we do take stopping corruption very seriously.
I then tell them about the compliance attorneys at my law firm who can help them sort out their FCPA and China corruption issues and the costs that will entail. They then usually call us back a few days later….
Corruption and bribery?
Don’t worry about the taxes.
Just don’t do it.
  • Ward Chartier

    The playing field for commerce in China is definitely uneven. The incremental “costs” or “taxes” for foreign companies to do business there are somewhat predictable. Foreign companies are seriously remiss if they do not factor these costs into their strategic decisions whether or not to do business in China.

    Investigators charged with enforcing commerce laws in China are partly measured by the fines they levy and collect. It’s easier to meet targets by focusing on companies with deep pockets – medium to large-sized foreign companies.

    Every year, universities in China matriculate more graduates with bachelor degrees than companies can absorb. Various bureaus in the government, like the Tax Bureau and Customs Bureau, hire many graduates and train them to be investigators and auditors. It’s not unusual for a foreign company to host a few audits of various kinds each year. The imperative of the auditors is to find something wrong and levy a fine. This cost is in addition to the cost of providing the administrative support for a few weeks to the audit team.

    There is an incremental cost to companies to take rigorous steps to be squeaky clean and endeavor to scrupulously follow all laws. Auditors and investigators can easily tell which companies are making the effort to be good corporate citizens, and will treat them accordingly.

  • China Medical News

    Many of the practices that GSK and other pharma companies such as Abbott have been accused of are in a grey area of corruption/promotion. Sponsoring doctors to attend medical conferences, and paying for their meals, for example. This is legal in the US, but has been deemed to be corrupt practice by the Chinese government. Likewise the payment of commissions on medicines prescribed. Is this a kickback or a legitimate source of income? In many countries ‘dispensing doctors’ are allowed to charge a markup for the medicines they prescribe. What’s happening now in China healthcare is not so much about law as politics. It’s part of a wider long term strategy by the government to get lower drug prices and improve access to treatment. As you suggest, it may be wiser for pharma companies to look at new sales strategies for pharmaceuticals – perhaps by providing them in partnership with insurance companies or hospital ‘risk sharing’ agreements at reasonable prices.

    • Wen Yu

      What you described used to be true in US a few years back. Not any more!
      There is strict limit on the dollar amount that can be dispensed to the
      doctor even if the interaction was permissible.

      Perhaps
      another option is to work with the regulator to elevate the field so
      everyone can be a bit less corrupted. It’s true that consumer is looking
      up to the multinational as a model. They’d be disappointed if they’re
      just as bad as the domestic firms. By the same token, I’m surprised that
      a generic firm like Actavis had to leave. They has nothing to offer in
      Chinese market!

  • On the Corner

    This strategy China uses against foreign companies and I definitely mean “against” is a page torn straight from the “Art of War.” The goal (which has always been the goal) is to lure multinationals in, absorb (you could read steal) their knowledge, then harass them to the point where they throw up their hands and say fuck it and leave. That is happening right now on a daily basis and as China’s economy slide deeper into the abyss they created for themselves this targeting of foreign companies for “wrong doing” will intensify…

  • r_s_g

    Actavis is not the world’s second largest pharma company. Not even in the top 20 by revenue.