Many of our clients that went into China years ago to have their products made there are now interested in selling those same products within China. One way for them to do that is to form a China WFOE for selling the products, but oftentimes the cost and the hassle of doing that is just not worth it, and there are other ways.
Foreign (non-Chinese) companies often ask our China lawyers how they can sell in China the product they are having made in China, without having to form a China WFOE. These foreign companies typically want to buy their own product from their Chinese manufacturer and then resell their product to a Chinese distributer or to Chinese end users. We usually have two major concerns with this sort of plan. One that VAT will need to be paid for both sales (the sale from the manufacturer to our client and the sale from our client to the distributer) and two, that a WFOE will almost certainly be required.
The key in these situations is to avoid having the foreign entity deal directly with the distributor. Typically the best way to do this is to have the sale made from the manufacturer to the distributor. The goal is to set up a system where 1) the foreign company earns a profit, 2) tax is paid on that profit, 3) the product is transferred to the distributor in way that provides for proper payment of VAT and proper credit for value of the goods for the subsequent payment of VAT by the distributor, 4) title to the goods transfers properly and 5) the foreign company remains in control of the process.
We usually handle these deals as follows:
1. The foreign company and the Chinese manufacturer enter into a manufacturing agreement that protects the foreign company’s intellectual property and deals with all other related manufacturing issues.
2. The foreign company enters into a separate license agreement with the manufacturer. This agreement provides that the manufacturer will sell the product within China to entities (distributors) selected by the foreign company. The sale to the distributors is made at an agreed price that includes profit to the manufacturer and a payment to the foreign company. We have characterized the payment to the foreign entity in various ways. In some cases, we characterized it as a license royalty, in other cases we characterized it as a sales agency fee. The characterization can also influence whether the agreement must be filed with the Chinese government, and where.
This arrangements are not without their complications and the following should be borne in mind:
- The exact method we use depends on the location of the manufacturer and of the distributor. Different localities have different rules. We make it a point to speak with the appropriate government officials before we draft anything.
- How to characterize the payment to the foreign company is critical and depends on the facts of the specific case.
- The manufacturing agreement can be simple or complex, depending on the nature of the product being produced.