Compliance of Sales Incentives for Business Operators

Under the Anti-Unfair Competition Law of the People’s Republic of China (hereinafter referred to as the “Anti-Unfair Competition Law”), offering sales incentives to employees of the counterparties directly by business operators is prohibited.  However, it is permissible for business operators to offer sales incentives to counterparties pursuant to relevant laws and regulations.  When a business operator offers sales incentives to a counterparty, the rewards mainly include price discount, rebates, paying commission fee to middlemen, giving discounts on certain items, and offering small-sum advertising gifts.  Current publicized administrative penalty cases indicate that certain business operators failed to be prudent in carrying out sales incentives, and thus were alleged to be engaged in commercial bribery by the administrative law enforcement authorities.  This article mainly discuss a variety of approaches to the topic under Chinese laws and regulations, and the compliance of sales incentives for business operators based on case study.

Price discount and rebates are most commonly used as sales incentives.  In accordance with Article 6 of the Interim Provisions of the State Administration for Industry and Commerce on Prohibition of Commercial Bribery (hereinafter referred to as the “Interim Provisions”),

“Discount, that is, part of profits surrendered in merchandise purchase and sales, refers to the favorable price given to a counterparty by a business operator when selling commodities in an expressed way and entering the surrendered profits into the account book, including a deduction of the total price in a certain proportion before payment and a refund in a certain proportion upon total payment. The phrase “in an expressed way and entering into the account book” refers to the requirement that, pursuant to the amount and payment method agreed in the contract, business operators shall clearly and faithfully enter in the account books which are set up pursuant to the law and reflect incomes and expenditures of the production and business activities or administrative operating expenses in accordance with the provisions of the financial and accounting rules. “

Under Article 7 [1] of the Anti-Unfair Competition Law, it is permissible for business operators to offer discounts or rebates to counterparties. There are two patterns that comply with Chinese laws and regulations:

1.Where a business operator is willing to offer a discount or rebate after the closing of a transaction, it shall conclude a relevant contract and obtain internal examination and approval. [2] If a counterparty has obtained a special invoice and applied for deduction, an Information Form of Issuing a Credit Note (hereinafter referred to as the “Information Form”) shall be filled out.  When this information form is checked and approved by the electronic system of the tax authority, the business operator needs to issue a credit note to the counterparty pursuant to the Information Form and shall be accounted for as a reduction of revenue and output tax.  If the credit note is issued as a VAT regular invoice, it can be directly issued via the invoicing system.

2.The business operator indicates the price and discount respectively on the same invoice for any taxable activity conducted, and the sales amount shall be the price with the amount of discount deducted. [3] Discounted prices are expressly shown as deduction from accounts receivable directly on invoices, and the counterparty makes payments in accordance with the invoice.

It should be noted that in above-mentioned patterns:

1.Where enterprises issue credit notes to offset the sales income, if they fail to carry out sales, returns and refunds of goods, or fail to make rebates or discounts in practice, they are deemed to falsely issue invoices.

2.Current Chinese laws and regulations do not have any restrictions on the proportion of discount or the time limit for issuing credit notes.  Principle states that, “No crime or punishment without law.”  Therefore, it is understood that the transaction is fair enough as long as both parties specify the proportion and time for rebate in the contract.

However, given that issuing credit notes will affect business operator’s sales revenue, and some business operators are not willing to specify their discount or rebate amount for the sake of good business reputation, they turn to adopt approachs as follows:

1.Fabricate contracts including but not limited to tourism contracts, sponsorship contracts and business consulting contracts with counterparty.  And the counterparty falsely issue general or special value-added tax invoice. Under Article 26 of the Implementing Rules for the Administrative Measures of the People’s Republic of China for Invoices,

“Entities and individuals shall issue invoices when business revenue is recognized after a business transaction has occurred. No invoices may be issued prior to the occurrence of business transaction. “

There exists high tax risk if the parties falsely issue invoices without any actual transactions.  Current tax control platform is connected to the national network, the law enforcement authorities conduct stricter supervision over invoices, and tax officers may cross check and verify the account of the counterparty according to accounting subjects, therefore fabricating contracts to falsely issue invoices is illegal and not feasible.

2.Enter into an Assignment and Novation Agreement amongst the counterparty and a third party, under which the rebates shall be paid to the third party and then paid from the third party to the counterparty.  Under Article 5 of the Interim Provisions,

“Failure to enter in financial acccoutns” refers to business operator’s failure to clearly and faithfully enter in financial accounts which shall be set up pursuant to the law and reflect incomes and expenditures of the production and business activities or administrative operating expenses in accordance with the provisions of the financial accounting systems, this failure may refer to actions not entering into financial accounts, transferring into other financial accounts or conducting accounting frauds”.

Therefore, due to the inability to truly reflect the transaction activities in a third-party transaction, the administrative law enforcement authorities will still regard it as commercial bribery.

Under Article 7 of the Interim Provisions,

“Business operators who sell or purchase commodities may pay commissions to middlemen in an expressed way. Where a business operator gives the middleman commissions, record shall be made in business operator’s account book; where the middleman accepts commissions, record shall be made in middleman’s account book. Commissions under the Provision refers to the remuneration paid by a business operator to a middleman who provides brokerage services to the business operator in transactions and possesses legitimate business qualifications. “

In accordance with laws and regulations, legal steps for payment of commission to a middleman is as follows: 1) Review of the middleman’s qualification and whether he is neutral; 2) Confirmation of the authenticity of the business activity; 3) Whether there is any corresponding contract prior to invoice issuance; and 3) Whether the payment is faithfully entered in account books. First, middlemen are subject to qualification review and shall possess legitimate business qualifications [5].  A middleman shall be neutral, that is to say, a middleman shall not be employed by the other party, or be authorized by the other party to handle relevant matters, and shall not be an entity or an individual who takes advantage of powers or influence to affect a transaction.  In Guizhou Taifu Trading Co., Ltd., Commercial Bribery Case (hereinafter referred to as “Taifu”) [6], the Company entered into a cooperation agreement with a travel agency.  It was agreed in the contract that the travel agency shall take the tourists to the shopping mall owned by Taifu, and thus was entitled to take dividends in accordance with product quantities and total amount contributed by the tourists, and the money earned was not faithfully entered in the account book as required.  The Administration for Market Regulation of Huangguoshu Tourist Area finds that Taifu is in violation of Article 7 of the Anti-Unfair Competition Law by taking advantage of the influence of the travel agency on tourists’ purchase of products, paying commission fees to travel agency, and requiring the travel agency to bring their tourists to the Company’s business places so as to seek a large number of trading opportunities with tourists.  In this case, the travel agency is not deemed as an middleman, and should be identified as “a third party who takes advantage of its influence to influence a transaction” to seek transaction opportunities and competitive advantages for the business operator.  Therefore, the act of Taifu constituted commercial bribery.  In Shanghai Shansi Geographic Information Engineering Technology Co., Ltd. Unfair Competition Case [7], in order to undertake vectorization business of maps and obtain more profits, Shansi Geographic Information Engineering Technology Co., Ltd. (Hereinafter referred to as the “Shansi”) paid rewards secretly without recognizing in its account book to relevant personnel at China Railway Shanghai Design Institute Group Co., Ltd.  The Supervisory Brigade of Shanghai Administration for Industry and Commerce decided that Shansi’s act constituted commercial bribery.  In this case, the relevant personnel is an individual employed by the counterparty rather than an middleman.

Secondly, the commission shall be expressly agreed. To be more specific, a contract concluded by the parties needs to address: 1) Agreement on the amount of the commission; 2) Conditions for the payment of the commission; and 3) Payment method and deadline.

Last, pursuant to Accounting Standards for Enterprises–Basic Standards, commission expenses incurred by a business operator in the course of selling goods or providing services shall be entered in “Sales Expenses”.

Complementary Gifts are defined as commercial discounts in the form of gifts, and goods rather than cash.  Under Article 7 of the Opinions of the Supreme People’s Court and the Supreme People’s Procuratorate on Several Issues concerning the Application of Law in Handling Criminal Cases of Commercial Briberies (Fa Fa [2008] No.33),

“Considerations in commercial briberies consist of cash and complementary gifts, as well as property interests with value, such as the offering of house decoration, membership cards with par value, tokens (tickets), and travel expenses. The specific amount shall be subject to the fees actually paid.”

Other than normal business transactions, giving away cash, complementary gifts and property benefits are extra benefits funneled directly to the other party, and will be deemed as commercial bribery regardless of the amount and form.  In normal commodity transactions, except for entering in income statement, it is required to take into account factors such as background of financial transactions in order to determine commercial bribery when a business operator is giving away complementary gifts to the other party.

Distinction between commercial bribery and giving away complimentary gifts in normal business transactions remain vague under current laws and regulations.  In normal business transactions, there are two main patterns for gifts giving from a business operator to the other party:

1.If a business operator gives away complementary products which are different from underlying transaction products, the VAT for the complementary products shall be deemed as sales of goods. [8] Where complementary gifts are given upon delivery by a business operator, the quantity and amount of the underlying transaction products shall be expressly stated on the invoice, and the complementary gift shall be remarked. In respect of account entries, since the requirement of “Sales volume and discount amount shall be indicated on the same invoice” cannot be met in this transaction, the price of the underlying transaction product shall be included in the sales revenue of primary business, while small-sum gifts shall be entered as sales expenses, large-sum gifts shall be entered as cost, and the output tax needs to be accrued.

2.If a business operator is selling ten products in an underlying transaction and giving away one gift of the same kind, for the purpose of taxation, discounts are usually reflected on the same invoice by reducing the unit price in practice.  In respect of accounting adjustment, ten products in underlying transaction shall be entered as sales revenue of primary business, and the complementary gift shall be entered as cost of primary business, and output VAT shall be accrued simultaneously.

The complimentary gifts in the aforesaid normal business transactions between a business operator and a counterparty shall, in practice, be determined comprehensively by taking into account factors under the Opinions of the Supreme People’s Court and the Supreme People’s Procuratorate on Several Issues Relating to Laws Applicable for Handling Criminal Cases of Commercial Bribery (Fa Fa [2008] No. 33),

“The background, the value, the reason, timing and payment method for financial transactions; whether the offeror has made any requests relating to duties to the recipient; and whether the recipient has taken advantage of powers to seek gains from the offeror.”

In Hangzhou Branch of Shanghai Yongcheng Food Co., Ltd. vs the Administration for Industry and Commerce of Xihu District, Hangzhou City [9], Hangzhou Yongcheng (hereinafter referred to as “Yongcheng”) and Jiaxing Meilijia Co., Ltd. (hereinafter referred to as “Meilijia”) concluded an agreement on matters relating to sales rebate on Dashifu fresh cream.  Meilijia was obliged to provide documentary materials to prove the quantity of the fresh cream purchased and used by the end of the year, and Yongcheng provided sales rebates or products of equal value after verification.  Yongcheng converted the sales rebates (hereinafter referred to as the “Rebates”) to products such as Dashifu fresh cream, stuffing products and delivered to Meilijia pursuant to the aforesaid agreement without issuing any sales invoices.  The Rebates were entered in the subsidiary ledger “Operating Expenses – Samples of Gifts” as “Sales Income” according to the market sales price by Yongcheng. The Administration for Industry and Commerce of Xihu District, Hangzhou City found that Yongcheng was engaged in commercial bribery, and retrieved materials such as Agreements on Rebate, subsidiary ledger, detailed list of customer rewards, detailed list of rebate gifts, delivery order for rebate gifts, bookkeeping vouchers and tax vouchers.  The Court of First Instance held that Meilijia had a decisive influence on the sales volume of Yongcheng products, and had a dominant position in production, supply and marketing.  Yongcheng’s offering of complimentary gifts to Meilijia at a certain proportion of the sales volume was not only giving Meijia extra economic benefits other than normal commodity trading, but also obtaining or stabilizing trading opportunities through inducement, which influenced the fair competition of other competitors in terms of quality, price, service, impaired the fair competition mechanism and thus constituted commercial bribery.  The second instance changed the judgment.  After the retrial, Zhejiang Higher Court upheld the administrative judgment of the second instance and held that whether Yongcheng’s act of unfair competition constituted commercial bribery should be analyzed in detail based on the facts ascertained: Whereas, 1)Yongcheng and Meilijia concluded an agreement, in which the catalogers of products, conditions, duration and other matters concerning the Rebate are expressly stipulated. Yongcheng entered the complimentary gifts in the subsidiary ledger of “Operating Expenses -Sales Samples” as “Sales Revenue” and paid taxes in accordance with the law; 2) The two companies have trademark strategic cooperation relationship and are affiliated companies; and 3) The Trademark Licensing Agreement expressly stipulates that Meilijia guarantees to use raw materials of Yongcheng during their production of the contract products bearing the designated trademark of Meilijia so as to guarantee the product quality and the friendly cooperation between both parties.  Therefore, the act of Yongcheng does not constitute unfair competition of commercial bribery and shall be regarded as giving away complimentary gifts in normal business transactions.    Under Article 8 of the Interim Provisions [10],

Business operators may give away small-sum advertising gifts in business transactions according to business practice.

A small-sum advertising gift is not defined in Chinese laws and regulations.  In practice, small-sum advertising gifts such as pens, notebooks, calendars, USB, mugs and key buckles customized by the brand, bearing brands’ name or attached with the company business cards or other branded reminders with the value not exceeding RMB200/person each time are acceptable.

To summarize, complimentary gifts provided by a business operator to its counterparty are limited to the products in the normal business transaction taking its transaction background into consideration, that are truly entered in account book, and included in the sales discount, and products such as small-sum advertising gifts that conform to the business practice (no invoice is required for record).

Generally, commercial activities including offering rebates, commissions to middleman which are expressly stated and faithfully entered in account books, product discounts of which invoices are issued and entered, and small-sum advertising gifts which comply with business practice in normal business transactions are legitimate sales incentives and are not prohibited by the law.  From a commercial perspective, sales incentives that not in compliance with laws and regulations involve price fraud, acts that exclude competitors in the same industry, damages the interests of consumers, and disrupts the normal order of the market economy.  From a legal perspective, tax evasion happens when business operators fabricate contracts or falsely issue invoices, and thus there are extremely high tax risks.  Any violation of the Anti-Unfair Competition Law will be subject to confiscation of illegal income and a fine by the administrative law enforcement authorities.  Any commercial bribery involving a large sum and other serious circumstances may also constitute a violation of the Criminal Law.

Therefore, the business operators shall adhere to the principle of prudence in accordance with laws and regulations: 1) Review the qualifications of the parties to the contracts; 2) Confirm the authenticity of the transaction activities; 3) Expressly agree on the amount, conditions, payment methods and terms of the sales incentives in the contract; 4) Make sure that the sales incentives are offered for the counterparty of the transaction rather than an employee; 5) Keep the items under accurate account title in the account books; 6) Consider whether a specific approach for sales incentives excludes other competitors and damages the legitimate rights and interests of consumers to a certain extent in purpose.

We suggest that business operators strengthen the compliance awareness and establish an ethics committee or compliance department to penetrate into every field of business departments in an all-round way.  A business operator shall conclude an ethics agreement with its counterparty, declaring that the company refuses any form of unfair competition practices.  If a counterparty figures out that any employee(s) of the business operator requests to obtain personal benefits from the counterparty by improper means in its business activities, the counterparty shall refuse and immediately report the case to the business operator; if the business operator figures out that the counterparty attracts or bribes the business operator’s employee by unfair competition practices, the business operator shall impose penalties against the counterparty by deducting scores for bid evaluation, restricting orders, cancelling cooperative intent or blacklisting.  In order to ensure the implementation of an appropriate sales incentive mechanism, to build a transparent and fair business environment, and to fulfill business potential under favorable market competition, business operators need to review the business transaction in advance and regulate it from time to time.

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