VAT Issues when selling a made-in-China product to a China based customer
This question comes in from a client in the USA:
My Bill of Material (BOM) is made in China and we currently do our final assembly in HK and USA. We now have customers in Mainland China. I’m thinking about moving final assembly from our current assembly centers in HK and USA to mainland China in order to be closer to the customer. I’ve read a number of articles about VAT leak. Some of my preliminary calculations seem to suggest that the labor and rent savings available in China as opposed to our existing 3PL operation in Hong Kong would be offset by the VAT leak. I am certain my calculations could be misguided, so I would like to ask if you can explain the situation in detail.
In my calculation I was adding VAT 17% less VAT refund 13%. Maybe that’s a fatal flaw.
Are any of the PassageMaker fees/markups added to the suppliers cost to equal a new export value of the product and then the VAT refund of 13% is calculated on that higher value? If so, perhaps this helps with the China VAT refund amount but I think it would cause us to pay a higher import duty in the US. I hadn’t really considered that yet.
Additionally, for the global export business, would PassageMaker be named as the exporter? The answer to this question would determine if we have to consider contractual changes with our European clients.
“VAT leak” is an informal term used by different people to mean different things. But the two most common interpretations are as follows:
VAT Leak- An inefficient processing of the VAT and VAT rebate, essentially giving the PRC gov’t more than needed. Overpaying on the VAT and under claiming the rebate. This type of “VAT leak” often happens when the party processing the VAT is not fluent in the process or lacks the infrastructure (example- only has the small tax payer status, lacks import/export rights or simply messes up the calculations/application).
VAT Leak- The VAT rebate in China ranges from 0 to the full 17% depending on how much the central government wants to promote a certain industry or product. When the official VAT rebate is less than 17%, sometimes this is called a “leak” because you pay in more than you get back. I personally don’t use the term “leak” in this situation because a leak implies that the plumber messed up and there is a hole in the pipe. Getting as much VAT rebate back as legally possible, even if less than the full 17%, isn’t a “leak”, it’s called “paying taxes”. Most people don’t say their checkbook leaks when they pay the IRS income tax each year, ha ha.
In my calculation I was adding VAT 17% less VAT refund 13%. Maybe that’s a fatal flaw. Are any of the PassageMaker fees/markups added to the suppliers cost to equal a new export value of the product and then the VAT refund of 13% is calculated on that higher value? If so, perhaps this helps with the China VAT refund amount but I think it would cause us to pay a higher import duty in the US. I hadn’t really considered that yet.
As the product delivered to your Mainland China-based end customer isn’t being exported out of China, this issue of a leak is not applicable as there is no VAT rebate on a domestic sale, but assuming you are looking at the impact of VAT on your global operation , then to answer your question, while we can’t legally change the VAT rebate, PassageMaker can certainly make sure you don’t have any VAT leak (in the first use of the term above) . We can do a case study for you if you could get some actual numbers to us. There are so many variables, so please give us actual data if possible. For example, off my head, here is what my accounting team will probably ask for:
- HS codes
- Annual volume (units and USD value)
- # of shipments in the year
- Supplier information
- Location
- Domestic sales license? In other words, do they offer “EXW with receipts” when they sell domestically
- In order to confirm the factory in China isn’t manipulating the pricing, it advantageous to ask for the price in three ways: EXW vs. FOB China Port vs EXW with Tax Receipt. But as that is a lot of work for the factory and they may take it the wrong way, it’s best to just give us what pricing details you have now for the case study and we’ll use that for the moment and did into more detail closer to actual placement of the PO w the factories.
- Destination information
For example, ship direct to client, or to FE HK or to FE USA? Do you wish to have the showcase assembly/QC area in SZ or HK?
For your reference, in terms of the Assembly and Inspection Labor taking place at PassageMaker, know that the labor rate is dependent upon the following variables:
- Annual volume
- Steadiness
- Space
- Amount of time needed per unit.
For example, let’s say that in a year X units are exported using Y total man hours. If all the units ship once per year (like a Christmas rush) this is a lot more expensive to coordinate (due to HR issues, OT, planning, space…) than a situation where X/12 goes out steady each month and I can assign a small group of staff to work full time on the project. If you can give us your latest details of ABCD on a global level, we may be able to get the costs lowered a lot. We could look at this while we are looking into the VAT issue above as the two go hand in hand.
Additionally, for the global export business, would PassageMaker be named as the exporter? The answer to this question would determine if we have to consider contractual changes with our non-China based customers.
Assuming PassageMaker is coordinating the exportation out of China, then PassageMaker is the exporter of record. But the importer of record into the destination is a bit more flexible. For example, the paperwork can be adjusted in HK or even via your company in USA.
But please know that if delivery is done via your company in USA, your subsidiary in HK or via an entity you control anywhere outside USA for that matter, then you would have tax exposure with the IRS. Consult your tax advisor in USA, but as I understanding it, PassageMaker is very much as arm’s length from your company (as there is a contract, not cross ownership), so it is probably in your best economic interest to have the paperwork flow under PassageMaker’s name. even if you appoint PassageMaker as the processing agent, to let your clients know you have skin in the game and real responsibility for the supply chain, you could sign an agreement with your customers that you still give guarantees regarding quality, IPR and such. In this fashion your clients know you and PassageMaker stand behind the products, but you are minimizing global tax in a fully legal fashion, thus keeping overall costs down for you and your clients.
Related Content:
Click here for other PassageMaker articles on the subject of VAT in China.
