Reliable exporters: find them and meet them

Full Question

I have a question for you but first a little background. I work for a hotel amenities company and we generally purchase finished goods (i.e. shampoo, conditioner HTS 330510, 330590) from our manufacturer in Shenzhen. However, we have started to move away from turnkey solutions and started sourcing components to send to our manufacturer for use in our products.

For example, we have located a plastic tube manufacturer also in Shenzhen that offers a higher-quality tube at a lower price. Our idea is to purchase the tube and send it to the manufacturer so that it can be converted to a finished good and then imported back to the US. Our terms are FOB Hong Kong with our manufacturer. Since the terms are FOB HK with our manufacturer, they took care of the VAT so we never really knew of its existence. Since we would be purchasing the tube, I assume that we would have to pay the VAT, correct? I can't seem to find a complete list of what items as assessed the VAT tax, but from the information from this website it would appear to be 17%. It would also appear that there is a 15% tax rebate since the component we purchased (now part of the finished good) will be exported back to the US. Our manufacturer is the exporter, therefore how would we be able to collect the rebate? Does our company have to be a registered entity in China in order to collect the rebate? Any assistance you could provide would be greatly appreciated. Thanks!

Answer

Thanks for your question. Just to clarify, there are two entities which are both named "manufacturer" in your question, but I assume you mean you want the "tube manufacturer to deliver to shampoo manufacturer and then the shampoo manufacturer to sell you FOB HK." To get right to the point (which can be hard when talking Chinese VAT as you have learned already!), here are some key points:

• You are correct, only a China-based, fully licensed company (regardless if Chinese or overseas owned) with export rights and VAT registration can apply for a VAT rebate.
• It is very difficult for a non-China based entity (such as a foreign buyer based overseas) to purchase components from one Chinese factory and sell them to another Chinese factory for further processing because in order to get the VAT rebate at exporting, the processing factory needs to show their receipts for taxes paid on their inputs. Only a China-based entity meeting the criteria above can provide official receipts (called "fapiao").
• The normal practice in your situation is to negotiate a price at which the "Shampoo manufacturer" buys the tubes you have "spec-ed in" for the appointed tube manufacturer. It would be like buying a toy from a toy factory and making sure it had a certain brand of battery included. The battery is "spec-ed in" as they say. You desire to "spec-in" the tube.

Like I said, those were the main points in theory about how VAT should work. Now let me tell you the gritty realities.

Sounds pretty easy at first, just tell your shampoo shop to buy the tube from appointed tube supplier... but seldom, unfortunately, is it that easy. Below I detail some of the common ways foreign buyers get screwed when attempting to do this.

"Not my fault"

a) If anything goes wrong, say a leaky tube, both parties will blame the other one and you will find it hard to negotiate a solution. So good contracts, backed by robust factory QC and 3rd party inspection becomes essential.

Hidden agendas

b) The tube manufacturer currently used is probably being used by the shampoo factory for a reason. Perhaps they have good quality and the shampoo shop is hesitant to change. Maybe they are accurate when they say, "let's not switch sub suppliers because while the tube you have found is less money, but it has poor quality and late delivery." But in my experience, it is probably true that the tube factory you found is better than the one the shampoo factory is using because so often the factories pick sub-suppliers based on family relationship, hidden commissions, proximity to production site and common linguistic/ethnicity (Hunan bosses like to work with Hunan suppliers, Shanghai with Shanghai, Zhejiang with Zhejiang people... ).

Unfortunately, the factory owner's "second cousin who owes a tube shop in the next city over", is rarely the best option for tubes in terms of price, quality, lead-time at a national level. In short, you may find some friction if you try to force a new sub-supplier into your shampoo vendor. But it all comes down to money, and if you have the leverage the supplier will most likely make the adjustments for you. BUT that is not the end of the story.

Collusion

c) It is not uncommon for sub-suppliers to partner up with your supplier in ways unknown to you; such as to create kick backs amongst themselves, VAT rebate shenanigans and general collusion to mutually milk the foreign buyer.

It wouldn't be fair for me to bring up the scary points above without offering some solutions to protect yourself.

• Get a feel for your shampoo supplier's willingness to use your tube supplier. If the move creates friction, you'll need to evaluate the potential savings against the costs of playing hardball and forcing the issue.
• Consider outsourcing the whole thing to a contract manufacturer who wants your assembly business and is not linked to any pre-determined APL (approved vendor list). In other words, you tell the contract assembly partner what to assemble in the way you want it made using the materials you desire. Critical point:
  • Make sure this partner is very honest (won't get hidden payments from sub suppliers)
  • Has clear pricing (no hidden costs)
  • Perhaps most important, they should offer a warranty on their work to avoid the "blame it on sub supplier" attitude.
  • And of course, they should know VAT inside and out, or you risk losing your full rebate.
• If you go with the current shampoo shop and spec-in the tubes, you may want to retain the services of an independent VAT specialist to do a supply chain review (in secret on your behalf) and ensure there is no funny business.