Transfer Pricing Insider
Volume 2, Issue 3
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Chinese Contract Manufacturing Structures: Navigating the New Landscape
Source: WG;&L Journal of International Taxation
The changes to the U.S. CFC rules and the new China CIT Law will force companies to examine intercompany pricing with related-party contract manufacturers and consider implementing new contract manufacturing arrangements, including a structure similar to the basic contract manufacturing paradigm discussed in this article
U.S.-based taxpayers in recent years have made extensive use of contract manufacturing arrangements with manufacturers located in the Peoples Republic of China (PRC or “China”), 1 particularly in the southern regions of the Guangdong Province, such as Shenzhen, Dongguan, and Guangzhou. 2 Evolving multinational business models (e.g., the acquisition of captive manufacturers located in the PRC ) and a growing and more affluent PRC consumer market have driven growth in, and complexity with respect to, PRC -based contract manufacturing arrangements.
Fundamental changes in both U.S. and Chinese tax laws are creating complications for PRC -based contract manufacturing arrangements. Generally, under new Chinese tax legislation, PRC manufacturers that are foreign investment enterprises (FIEs) 3 will be subject to higher PRC income tax rates. Moreover, foreign-based principals with a physical presence in China must navigate a new definition of a PRC tax resident—which now subjects non-PRC enterprises with a place of effective management in China to worldwide PRC taxation—in addition to existing permanent establishment (PE) rules. Yet, proposed U.S. rules addressing the taxation of contract manufacturing arrangements put greater pressure on these foreign-based principals to take an active part in the manufacturing process to avoid taxation under the U.S. Subpart F regime. Thus, U.S. taxpayers with China-based contract manufacturing arrangements may be forced to deal with both increasing tax costs and risks. U.S. taxpayers using or planning Chinabased contract manufacturing arrangements should reexamine these arrangements and plans within the context of the significant tax law changes.
This article provides an overview of contract manufacturing in China, including highlights of the recent PRC tax reform and the U.S. contract manufacturing Proposed Regulations and the impact of the rules on a basic contract manufacturing arrangement involving a controlled foreign corporation (CFC ) organized outside China (in a tax-favored jurisdiction) that engages a China-based contract manufacturer to produce finished goods ("basic contract manufacturing paradigm").
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