China’s bonded refurbishment policy seeks to ease pressures for medical device businesses
Kenneth Leung of KPMG China considers how the relaxation of restrictions on bonded refurbishment can potentially ease supply chain disruptions encountered by medical device businesses in China.
After sales maintenance of medical devices: Challenges
COVID-19 has led to increased sales demand for medical device businesses but they are also facing challenges in fulfilling after-sales service needs. Failing to meet after-sales and maintenance obligations could have commercial consequences and create reputational risks. The disruption to supply chains has amplified these difficulties:
Problems in providing new or replacement medical devices to medical institutions
Production of new devices or refurbishment of used devices cannot be conducted at a rate fast enough to meet medical institution needs, as many manufacturers may be subject to lockdown restrictions.
Transporting used devices or core parts back to the manufacturers for maintenance inspection and refurbishment
Managing the logistics for the used devices and core parts creates challenges, especially when the users of the medical devices are not located in the same country. As warranty and after sales service obligations often remain with the manufacturers, the used devices would need to be exported and then reimported back to the countries where the devices were manufactured. Managing the shipment of these used medical devices in the context of COVID-19 can be costly due to reduced global transportation capacity.
Managing bills of materials for refurbished devices
It is understood that refurbishment or remanufacturing of the used machines may be more complex than making new devices from scratch. For instance, the bills of materials (BOM) for making of a new device is often static but the BOM for each of the medical devices lined up for refurbishment could vary significantly, depending on several factors. Relevant factors include the age of the machine, prior refurbishments already performed on the device, and the level of recent wear and tear.
Country specific restrictions on importation and refurbishment of used devices
Under environmental protection rules, many countries impose restrictions on the importation of used goods, and refurbishment activities for imported goods may be subject to business regulatory approval. Some countries exceptionally allow for importation and refurbishment provided that the goods were originally made in the country. They may require that refurbishment activities must take place in designated areas (e.g. in free trade zones). It is worth noting that such restrictions existed before the pandemic and there are now signs of relaxations in some countries, including China.
China has become a key player in the manufacturing of high-end medical devices. Most of the top 10 global medical device companies have manufacturing facilities in China and the stable COVID-19 situation means that China is viewed as having device refurbishment capacity. However, under the current Chinese business and regulatory rules, importing used equipment (including medical devices) into China for refurbishment purposes is a restricted business activity which is subject to layers of approvals. However, a recent Chinese State Council (i.e. cabinet) Circular, relaxing restrictions, paves the way for China to serve as a global refurbishment hub.
Relaxing restrictions on bonded refurbishment
On July 2 2021, the Chinese State Council issued Circular Guobanfa  No. 24 (Circular 24) setting out a suite of directives on the development of a new business model for international trade, and among these, including new rules to facilitate the bonded refurbishment of imported used medical equipment in China. This includes:
Setting out the overarching principles – enhancing the level of development of the bonded refurbishment business sector.
Further support should be provided to bonded refurbishment activities that are conducted in comprehensive bonded zones (CBZs), including by pilot free trade zone businesses. This requires that the refurbished items are included in the catalogue of refurbishment products (catalogue).
The catalogue should be updated on an ongoing basis and consideration should be given to include medical equipment and other products into the catalogue. The circular has specified that refurbished items would need to be imported from and exported to overseas.
Provincial governments will be responsible for the overall development and continuous monitoring of the bonded refurbishment projects.
Explore pilot arrangements to allow qualifying businesses which are located outside of CBZs to start bonded refurbishment activities for their self-manufactured products. The pilot refurbishment activities should not only be of high tech and high value nature, but also meet the prescribed environmental production requirements. A catalogue and regulatory and assessment rules will be developed.
A more comprehensive policy for bonded refurbishment should be ready by 2025. This will be led by the Ministry of Commerce, with support from the Ministry of Finance, Ministry of Environmental Protection, General Administration of Customs and the State Taxation Administration.
Chinese business regulatory, tax and customs implications for bonded refurbishment
The relaxation measures set out in Circular 24 are certainly welcome for business.
Based on discussions with several medical device businesses, one possible solution is to set up a global refurbishment hub in China. Key considerations include the following:
Planning the right location for the refurbishment hub
As Circular 24 requires the bonded refurbishment activities to be conducted within CBZs, some of these CBZs have started to use the Circular 24 relaxation to attract new investments and have provided approvals more readily. Some CBZs can offer local incentives such as reduced land costs, reduction of local fees and levies, or refund of taxes attributed to local government.
This being said, businesses are advised to take a balanced view when performing site selection. Some businesses have indicated that these CBZs are located far from their current manufacturing sites and this means that moving skilled workforces from the current manufacturing sites to the CBZs could be an extremely difficult assignment from a logistical or human resource perspective. Businesses have also pointed out that they would prefer to set up in a CBZ which is close to their localised parts suppliers.
VAT and transfer pricing implications
Businesses must also factor in Chinese tax cost burdens when setting up global refurbishment hubs. Although bonded operation means there would not be any custom duty costs associated to the refurbishment business, businesses would still need to consider the VAT costs for the new business model.
For the purchase of parts from suppliers in China, the movement of parts from outside a CBZ to the refurbishment facilities in CBZ would trigger Chinese export VAT refund implications. Depending on the export VAT refund rate applicable to these parts, the suppliers could suffer VAT leakage (e.g. where the export VAT refund rate is lower than 13% VAT imposed on the sale) and these costs could be passed on to the refurbishment businesses.
It should be noted that the refurbishment fees to be charged may be entitled to an export VAT refund, subject to normal export VAT refund conditions (e.g. forex and customs documentation requirements would need to be met). As the revenue arising from undertaking of refurbishment activities would likely involve two related parties, a detailed TP study should be conducted in order to ensure that charges would be made at arm’s-length.
Customs bonded management implications
As noted above, managing BOMs for the devices requiring refurbishment is not an easy task. The faulty parts need to be taken down from the refurbished device and then be shipped out of China, and failure to handle this properly would lead to severe customs consequences. This requires businesses to maintain a robust BOM monitoring system.
Other business regulatory requirements
There may be regulatory restrictions in other countries that also impact bonded refurbishment in China. For example, a leading Japanese medical device business noted that their best-selling medical scanner model has a built-in function and it can capture and store patients’ images in the devices. The device is often used in small clinics with limited IT infrastructure (e.g. no central data storage, in contrast to large hospitals). Under Japanese regulations, patient data is required to be kept in Japan unless the patients have specifically approved the movement of their individual medical records to overseas.
Given thus, the medical device business is required to undertake data backup and clean-up activities before the devices are exported. Similar regulatory restrictions may be imposed by other countries. These could be ‘deal breakers’ if the medical device manufacturers cannot meet the local regulatory requirements.
Realising the benefits
Circular 24 is good news for medical device businesses, as the measures can certainly help to ease the unprecedented pressure brought by the pandemic. However, given that the relaxation policy is relatively new and multiple Chinese authorities are involved in the approval of bonded refurbishment operations, it is advised that businesses consider the following actions:
Closely monitor the release of the catalogue and the implementation rules to see whether the business’s devices will be permitted to be refurbished under the bonded arrangements. It is expected that the application process, customs compliance requirements (e.g. bonded material movement and consumption records maintenance requirements), as well as environmental protection compliance requirements, will be set out in the implementation rules.
Undertake a thorough feasibility study and assessment on key areas such as business regulatory, commercial, tax, customs, legal as well as SHE (i.e. safety health and environment) before making significant investments. The feasibility study should also include a location study which encompasses logistics, local government support (e.g. incentives and subsidies) and the possibility of introducing transaction structures aimed at optimising the tax efficiency of the refurbishment supply chain.
One particular consideration that businesses should make is that, although there are many CBZs in China, not all of them are physically located at areas that would be suitable for the undertaking of bonded refurbishment. For instances, some CBZs may be located in inland areas which are far away from ports while some CBZs may not be established in regions where local incentives or subsidies could be offered to businesses. Businesses are advised to act fast with a view to start working with the CBZs which can match with their planned investments.
Explore the possibility of adopting technology to manage refurbishment operation. For instance, when managing the trade compliance obligations, consider using customs technology tools to fulfil the bonded materials monitoring requirements imposed by the Chinese customs authorities (i.e. complicated bonded materials flow).
Form a multi-disciplinary team with a dedicated project management officer assigned to the project. The design and implementation of a refurbishment hub is an intensive exercise which requires multiple business departments to work together. A RACI model (i.e. responsible, accountable, consulted and informed) can help the various team members to have a clear idea on the actions to be taken.
For the successful running of a new bonded refurbishment hub, businesses are advised to seek professional assistance in dealing with the application processes and in setting up the bonded refurbishment operations. Opportunities (e.g. incentives and subsidies) and risks (e.g. bonded material handling) can best be managed with expert support and guidance.
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Kenneth Leung is the lead partner of KPMG China’s supply chain tax practice which consists of 150 professionals working in Beijing, Qingdao, Tianjin, Shanghai, Guangzhou, Shenzhen and Hong Kong SAR.
Kenneth has extensive experience in advising companies on indirect tax (VAT, customs duty, trade compliance, consumption tax and green taxes), in particular, indirect tax-efficient supply chain as well as indirect tax cost and risk management. He has also been assisting businesses in formulating their indirect tax strategies, processes and planning ideas when making investments and operating internationally, across a variety of industry sectors.
Kenneth has been working closely with the Chinese government and has been one of the leading advisors to the indirect tax policy makers. He has been working with the National People’s Congress, People’s Bank of China, Ministry of Finance, State Taxation Administration and General Administration of Customs on VAT reform and other legislative projects relating to indirect taxes such as the VAT Law, Consumption Tax Law, Environmental Protection Tax Law and Hainan Free Trade Port Law. In addition to working with the central government departments, he has also been advising local governments such as Shanghai and Beijing on the introduction of VAT pilot reform, as well as local incentives to attract investment.
Kenneth also has extensive experience in assisting companies to design and implement digital solutions to manage their taxes. Technology projects led by him include the setup of electronic invoicing platforms, design of global trade and customs management systems, and implementation of bespoke indirect tax management systems for multiple jurisdictions.