Dr. Nataliya Esakova is Partner at RSM Ebner Stolz and Sven Stuckmann is Director at RSM Ebner Stolz.
“We are increasingly in a situation where we have to offer “Made in China” but this involves products that we actually produce in Germany because localization is not worthwhile due to the quantities involved.
So we come to the question, what are the minimum requirements for the “Made in China” label from a Chinese perspective when these products contain components or modules imported from Germany?”
This is not the only recent case among our clients and their Chinese subsidiaries where “Made in China” has been in the spotlight, particularly those involved in government procurement.
Through this inquiry, we will provide you with a practical view of “Made in China” labelling through product localization, as well as a view of China in the context of global industrial chain restructuring from the view angle: What has happened in China’s policy that creates the demand for “Made in China” label?
“Made in China” label in the Chinese legal and practical context
The “Made in China” label is commonly understood as the mark of Place of Origin.
In China, the Place of Origin is interpreted in the Regulation of the People’s Republic of China on Place of Origin of Imports and Exports (“State Council Announcement No. 416”) and the Decree of the General Administration of Customs of People’s Republic of China No. 122 (“No.122”).
- If a product is sourced from multiple countries, the place of origin is the country where the product undergoes its final substantial change and completion.
- “Undergoing final substantial change and completion” refers to a change in the tariff classification (HS code), specifically a change in the four-digit tariff classification of the products.
- If the change in tariff classification does not reflect a substantial change, a minimum ad valorem percentage of 30% is required as an additional criterion. The ad valorem percentage is calculated as follows:
The ad valorem percentage = (The price of finished goods paid to the manufacturer – Value of main components imported from abroad) / The price of finished goods paid to the manufacturer.
Example from a customs officer
If the raw materials or components are imported from Germany and assembled into finished goods in China, these goods will meet the requirement of substantial change and can be labelled as “Made in China”. If the assembly process in China only involves labelling or packaging, such goods cannot be labelled as “Made in China”.
The demand for the “Made in China” label reflects a small corner of China’s policy portrait at the critical juncture of a historic confluence of the new round of technological and industrial revolution and the transformation of China’s economic development mode.
Government procurement: National policy tending to favor domestic goods
The tendency for domestic goods in government procurement activities is legally based on the Government Procurement Law of the People’s Republic of China (amended in 2014) and the Measures for the Administration of Government Procurement of Imports (2007).
State authorities, institutions and organizations are required to procure domestic goods, unless the goods cannot be procured in China or cannot be procured in China on reasonable commercial terms.
The procurement of imported goods is subject to review procedures and supervision by the Ministry of Finance.
This policy has established the dominant guideline for government procurement activities, while leaving one key point for discussion: whether the goods produced by foreign-invested enterprises in China are domestic goods.
This question was somehow answered in the Foreign Investment Law which was issued in March 2019.
“Made in China 2025”: Strategic vision and planning for building manufacturing power
The ten-year national strategy plan “Made in China 2025”, issued by the State Council of the PRC on 8 May 2015, sets out China’s vision to build a new manufacturing power that will underpin its economic development and strength.
The strategy plan proposes five major projects: the manufacturing innovation center construction project, the intelligent manufacturing project, the industrial foundation project, the green manufacturing project and the high-end equipment innovation project.
Among the principles of the strategy plan, the following points are to be noted.
- Major focus on independent capability
With a major focus on the independent innovation and development capability, it promotes independent intellectual property rights, independent supply of key materials, independent design capability, independent research and development in basic and strategic areas from a strategic level. - Principle of opening up and cooperation
The strategy plan aims to remain open to the international market and resources as well as to enhance international exchanges and cooperation.
Under this vision, China has ranked first in the world in the size of its manufacturing industry for 13 consecutive years. With 41 major industrial categories, 207 medium industrial categories and 666 small industrial categories, it has all the industrial categories in the United Nations Industrial Classification and is able to provide more domestic goods.
The government procurement policy is also rooted in this ongoing vision.
New Era of Foreign Investment Law: Equal participation in government procurement
At a time of global industrial chain being deconstructed and reconstructed, China is seeking to attract foreign investment and to build international competitiveness with links to international markets and resources.
The Foreign Investment Law, effective from January 2020, makes clear provisions in the form of a law to promote the equal participation of foreign-invested enterprises in standardization work, fair participation in government procurement and the broadening of financing channels.
It clearly states that, products manufactured by foreign-invested enterprises within the territory of China shall be given equal treatment in government procurement.
In accordance with the Foreign Investment Law, the Ministry of Finance has taken the following measures.
- Fair competition
Promote fair competition by issuing two circulars in 2019 and 2021, requiring all regions and departments to eliminate provisions and practices that discriminate against suppliers by imposing unreasonable conditions such as ownership form, organizational form and shareholding structure. - Equal treatment
Enforce the requirement of equal treatment of domestic and foreign-invested enterprises in government procurement activities, by issuing a circular in 2021, requiring all regions and departments to give equal treatment to products manufactured by domestic and foreign-invested enterprises in China in government procurement activities, and to safeguard the right of domestic and foreign-invested enterprises to participate in government procurement activities on an equal basis in accordance with the law. - Strong supervision
Strengthen the supervision and administration of government procurement by improving the mechanisms and channels for questioning and complaining about government procurement and for administrative adjudication.
Following these measures, at a regular meeting of the State Council Information Office in 2023, the director of the Department of Economic Construction mentioned that the Ministry of Finance would continuously work on optimizing a fair and competitive business environment for government procurement. The focus in the next step would be on:
- Revision of the Government Procurement Law:
Actively promoting the revision of the Government Procurement Law and the harmonization of the Government Procurement Law and the Bidding and Tendering Law, in an effort to improve the systematic and synergistic nature of the legal system for government procurement; - Clarification of “produced in China”:
Clarifying the specific criteria for “produced in China” in the area of government procurement, and striving to ensure that domestic and foreign-invested enterprises participate in government procurement on an equal basis with respect to the products they produce within the territory of China; - Implementation of inspection procedures:
Carrying out special inspections, to ensure that enterprises can participate in government procurement on an equal basis, and that unlawful and irregular acts such as the differential or discriminatory treatment of foreign-invested enterprises are corrected and investigated.
The promulgation of the Foreign Investment Law and subsequent implementing measures provided a legal basis and perspective for foreign-invested enterprises to participate in government procurement. In this background, foreign-invested enterprises seeking market opportunities in the area may need to give attention to the progress of the Government Procurement Law revision and interpretation in the coming period.
Tax risks arising from localization
Changes in value chains that result in value creation steps being relocated to another country can lead to taxation consequences in the country that transfers (i.e. loses) value creation steps. German tax law in particular contains extensive regulations designed to ensure exit taxation. These also include German transfer pricing regulations on business restructurings.
Business restructurings often entail a so-called relocation of functions. According to the applicable regulations, a relocation of a function is fulfilled, if a function including its associated opportunities, risks and assets or other benefits (related to the function) is entirely or partially transferred to a receiving entity, so that the receiving entity is able to exercise this function or extend an already existing function. In addition, it is necessary that the transferring company is limited in the exercise of the corresponding function. This means that it cannot carry out the respective function to the same extent as it did before the relocation of functions.
A function is a business activity that consists of a combination of similar business activities carried out by certain units or departments of a company. Typical examples of functions are general management, research and development, material procurement, warehousing, production, packaging, distribution, assembly, processing or finishing of products, quality control, financing, transportation, organization, administration, marketing or customer service. It should be noted that, in practice, German tax authorities do not have high requirements on the existence of a function. In cases where individual or several production steps are newly established in China, this view of the German tax authorities must be critically considered.
A transfer of functions may also exist if the function is only temporarily performed by the receiving entity. Moreover, in order to prevent arrangements to circumvent transfers of functions, the transactions of the last five financial years must be taken into account when examining whether a cumulative transfer of functions exists.
If there is a relocation of a function, then not only the individual cross-border intercompany transactions taking place must be considered and remunerated on an arm’s length basis, but rather the whole function transferred combined with all corresponding assets and other advantages as one transfer package (comparable to a company valuation). In selected cases, where a specified escape clause is applicable, an arm’s length pricing approach for the individual transactions and asset transfers taking place is sufficient.
For the sake of completeness, it should be noted that a relocation of a function is an exceptional business transaction and a documentation must therefore be prepared promptly, i.e. within 6 months of the end of the financial year in which the relocation of function took place. The records must be submitted to German tax authorities within 30 days of being requested. In addition, it should be checked whether the relocation of the function is subject to the reporting obligations according to DAC6.
Therefore, we recommend reviewing critically the tax implications of a localization before implementing any steps. We are happy to assist with an respective tax risk assessment.
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Dr. Gerald Neumann
Partner
