by Klaus Koehler and Kristina Koehler
Many international companies -- whether they are multinational corporations or small- to medium-sized enterprises -- see China as a sales market that offers great potential.
For companies interested in selling to the wholesale market, the more that specialist or precision production is moved from international markets to China, the more production plants are built. And companies that would typically supply high-end production companies in their home countries are forced to move with their customers to China.
For companies interested in the wholesale, retail and e-commerce markets, this market has exponentially risen over the past 10 years and has been especially pushed by the growth of the consumer market in China.
There are various sales structures available to companies entering the China market, and it is just a matter of understanding which suits their business model.
Depending on the product category, China requires various approval and registration processes. These procedures are carried out exclusively by state authorities. Foreign inspection agencies are permitted to perform some secondary tasks, such as production site inspection.
It is important to understand the legal framework on product liability in China. One must adjust the existing sales contract in accordance with the mandatory regulation under Chinese law and use the possibility to limit the liabilities as producer or seller as much as possible.
It is recommended to register the trademark as soon as possible as China has the “first-to-register” rule. This means that whoever files a trademark first (by filing date) has priority to other applicants for the same trademark. If ignored, trademark-infringers are likely to capture valuable brand names and other foreign trademarks.
Trademark protection is advisable especially for small to medium enterprises whose trademark is only popular in their home markets. Marks that are recognized as “well-known” enjoy a special protection. Once a trade mark is granted, the owner enjoys exclusive right to use the sign in relation to the goods or services covered by the trademark, and may prohibit others from using it without prior consent.
Here are some of the main options companies have when selling in China.
A foreign company has the option of establishing a network and identifying potential buyers or even partners by visiting or exhibiting at relevant trade fairs in China.
Selling into China without any local presence is naturally the first step for many, but if a company wishes to expand and use the full potential of the China market, a local presence is unavoidable.
Before entering into a business relationship with a potential Chinese partner, due diligence is an important factor. It is essential to check references and conduct a thorough company background check.
The biggest challenge for foreign suppliers is to find dedicated, reliable, professional and credit-worthy distributors. A long-term, focused and consistent strategy is needed to access and profit in the market.
Companies looking to begin their distribution into China should either establish their own distribution networks or work with several regional distributors.
Large international companies tend to localize part of their product lines through joint ventures or solely owned enterprises, while establishing domestic distribution networks.
Imported products are then sold through the same network. A first step towards a sales representation in China would be to identify a distributor or agent who will promote and sell the products to the Chinese market.
However, this is not always a recommended method as the distributors can be in conflict due to customers that produce similar products.
Setting up a Hong Kong company for sales activities with China and the rest of the world has many advantages. When selling to the Chinese and/or Asian markets, the company can enjoy significant tax and operational benefits - with or without a mainland China entity.
The foreign company can use the Hong Kong company as a re-invoicing center for sales to China and other Asian countries and accumulate profits at favorable tax rates. The regular tax on profits is 16.5 percent, but if the profits of a Hong Kong company are generated through offshore business, they are tax free.
An important point to this structure would be that a Hong Kong company cannot issue Value-Added Tax (VAT) Invoices to its customers in mainland China and in addition it cannot invoice in renminbi (RMB).
Should the customers in mainland China be willing to settle the invoices in a foreign currency and handle all importation requirements themselves, then a Hong Kong company will suffice.
And lastly if a company is producing in China and wishes to sell in China, then the Hong Kong company would be obligated to export the products out of the territory of China and re-import them once again to the end customer.
The disadvantage of this is logistics costs as well as customs duty to be paid by the end customer upon re-import of the goods.
One option to get around this is to utilize the Bonded Logistics Parks that allow suppliers in China to export without actually having the goods leave China. The Bonded Logistics Parks are areas of land in China that are considered “non-China” in customs terms and as such suppliers can apply for the VAT refund upon the export.
This method does lower logistics costs but the end client in China would still be required to re-import the goods once purchasing them incurring customs duty costs.
If a company wants to act as the importing or domestic agent in China, have its own independent warehousing facilities for local inventory purposes and to invoice its Chinese customers in RMB, a limited company would need to be established.
A limited liability company allows foreign investors to manufacture, process, assemble, trade, distribute or deliver services in China, without joining together with a Chinese partner.
Setting up a limited company does not necessarily mean that it can engage in any sort of activities, as may be the case in the West and certainly in Hong Kong. Limited companies can only be operated within the scope of business as approved by the authorities.
The main disadvantage of establishing a limited trading company in China to handle the import business is the larger investment requirement and higher risk involved.
A company may want to establish its own production facility in China in order to cater to the China and/or Asian markets exclusively. This would enable the company to produce specifically-designed products for the China and/or Asian markets as well as allowing for faster and more efficient production and delivery times
The company could then not only import products that are not within their production capabilities but also sell all these products domestically.
The Hong Kong trading company could then be the sole agent for export of these products onto the Asian / International market.
In addition, a limited company holds many advantages if a company is solely looking to enter the China market and no other market in the Asia Pacific region.
If a company is producing in China and is looking to sell in China, the only possible tax and logistics efficient structure would be through a China-registered entity. This option allows the foreign investor to have full control over its clients, pricing methods and goods flow in the country.
Many companies also wish to invest directly in China without any type of holding structure. The reason for this may be that the double taxation agreements are not preferential between Hong Kong and the home jurisdiction or simply because of the cost issues associated with establishing and maintaining a holding structure.
A company must look at all points along a distribution network to see what tax advantages can be gained not only in the short-term but in the long-term strategy and development.
With all these options available, it is important for a company to evaluate its best China sales strategy and to consider which option best fits their profile.
There is no reason for foreign investors to be nervous or hesitant about establishing a Hong Kong and/or China operation. The key for many investors is to make sure they do not become excessively complacent and to avoid any fraud or non-compliance issues.
It is advisable to obtain advice and assistance through a law firm in terms of contractual issues and product liability information, and an accounting and tax advisory firm to investigate the long-term tax efficient structures that can be created.
Klaus Koehler, Founder & Chairman of the Klako Group, has lived in Hong Kong since 1970. After many years of international trading activities with Hong Kong and mainland China, he established Klako Group Holdings and its associated entities in 1979.
Kristina Koehler, China Director of the Klako Group, has been working in China’s legal and accounting industry since 2003 advising foreign clients on tax, accounting and trade-related issues. She has worked on numerous complex transactions including foreign direct investment and M&A deals.