Accounting Treatment Challenges of Cost Attribution and Profit Transfer under Consignment Processing Mode
A mainland Chinese company (A) provides raw materials free of charge to a processing factory (B), which processes them, charges a service fee, and sells the finished products back to A; simultaneously, B supplies goods to Hong Kong parent company (C), but C pays B's Hong Kong representative office (D). This arrangement results in A retaining raw material costs while C's COGS is understated, creating tax risks of profit transfer from China (tax rate 25%) to Hong Kong (tax rate 16.5%). The article raises four core questions: cost attribution, feasibility of zero-value transfer, characterization of profit transfer, and timing of ownership transfer of finished products.
Currently working in Beijing/Hong Kong, facing an unprecedented situation, and hope to get advice from everyone. The following is the transaction background:
Mainland China Company A purchases raw materials and provides them free of charge (not as a sale) to processing factory B. B uses the raw materials provided by A, adds some of its own materials, and after processing, returns the finished goods to A. A pays B a service fee (including part of the additional raw material cost).
Hong Kong Company C holds 100% equity of Company A. B also supplies finished goods to C, but C does not directly pay B a service fee; instead, it pays D (B's representative office in Hong Kong).
In this transaction, the price of finished goods obtained by C is lower than that for A, because the raw material cost always remains in Company A and is not transferred at any stage. This results in a higher profit margin for C in Hong Kong and a lower profit margin for A in Mainland China.
Sales within Mainland China seem to be fine: A records raw materials in COGS (when B uses them) and sells the returned finished goods, so COGS reflects the true production cost. However, for finished goods sold through Hong Kong, the COGS is inaccurate because it lacks the raw material cost that remains in Company A.
Therefore, I face the following issues:
- A retains COGS costs that should belong to C;
- I think it cannot be corrected by 'gifting' inventory from A to C at zero value, and since it involves cross-border (China to Hong Kong), export procedures are required;
- This is effectively shifting profits from China (tax rate 25%) to Hong Kong (tax rate 16.5%);
- Under the consignment processing model (Company C), when does ownership of finished goods transfer? Especially for C?
Please forgive me if the above description is not clear enough.