Two-Invoice Pressure After VBP

Life Sciences & Healthcare Blog · Legal cluster

Volume-based procurement (VBP) collapses the multi-tier margins that the old pharma distribution model depended on, and the failed fix is predictable: a pass-through entity that "holds a ticket" — moves invoices but no product, no logistics, no promotion — creating an invoice story waiting for an inspector. This article explains how a pharmaceutical or medical-device company redesigns its China distribution channel under the Two-Invoice System and VBP pressure so that title transfer, logistics, promotion, and the fapiao (special VAT invoice) chain tell one truthful story, and where the tax, anti-monopoly, and anti-corruption exposure actually sits.

Why this matters: the channel redesign is a legal event, not a commercial exercise#

The Two-Invoice System, introduced through the health-commission policy framework (Guoweiyi Fa [2016] No. 4), limits the number of invoicing layers in the drug supply chain — broadly, manufacturer to distributor, distributor to healthcare institution — precisely so that prices can be traced and inflated margins squeezed out. When VBP then sets procurement prices at or near the manufacturer's production cost, the economics of maintaining a multi-layer distribution network collapse. Companies that cannot accept thinner margins often try to preserve the old structure by other means: a shell entity issues invoices to keep the channel "alive," an empty layer holds a ticket between the manufacturer and the hospital, or a nominal service company receives payments for services it never performs.

Those workarounds convert a commercial problem into a legal one. The invoice chain becomes a tax problem, the layer structure becomes an anti-monopoly and anti-unfair-competition problem, and the payments for "relationship maintenance" become an anti-bribery problem. This article treats the redesign of the channel as a compliance project with three intertwined legal frameworks — tax, competition, and anti-corruption — and gives the operating plan that keeps all three clean at once.

Governing legal and statutory framework#

The Two-Invoice System policy (Guoweiyi Fa [2016] No. 4) and the Drug Administration Law#

The Two-Invoice System limits the invoicing layers in drug distribution, and the Drug Administration Law of the People's Republic of China (2019 revision) imposes quality and traceability obligations on the entire supply chain. The 2019 revision added provisions on the whole-process traceability of drugs, which means the regulator can, and does, follow the goods: the physical movement of product must be consistent with the movement of invoices. A layer that issues invoices without moving product is not a distribution layer at all; it is a paper layer, and the moment an inspection matches invoices to logistics records, the paper layer is exposed.

PRC Anti-Monopoly Law and Anti-Unfair Competition Law#

The Anti-Monopoly Law of the People's Republic of China prohibits monopoly agreements and abuse of market dominance, and competition enforcement in the pharma sector has repeatedly targeted resale price maintenance — controlling the price at which distributors resell products. A channel that is restructured to preserve resale-price control through a pass-through entity attracts both monopoly-agreement and vertical-restraint scrutiny. The Anti-Unfair Competition Law prohibits commercial bribery, including payments made to obtain transactions or competitive advantages. Every payment in the redesigned channel must therefore have a genuine, documented commercial substance — logistics, storage, promotion, or other performed service — because any payment that exists only to buy access is bribery, whatever the invoice says.

Anti-Unfair Competition Law of the People's Republic of China, Article 7: An undertaking shall not use bribes to seek a transaction opportunity or a competitive advantage... including by giving property or other means to the counterparty to a transaction, the party that manages or handles relevant affairs on behalf of the counterparty, or the employee of the counterparty, in order to obtain a transaction opportunity or a competitive advantage.

Key legal analysis and enforcement precedents#

The State Taxation Administration (STA) has made pharma supply-chain invoicing a priority enforcement target. The published enforcement record includes tax cases against "pass-through" invoicing entities in pharmaceutical supply chains, where companies issued invoices without genuine goods or services transactions, in some cases characterising the conduct as invoice fraud and, where intent and scale were established, referring the matter to criminal authorities. The enforcement message is blunt: an entity that exists to balance invoices is not a company; it is an invoice machine, and its invoice machine will be examined as such.

Anti-bribery enforcement in the pharma sector has followed the same trajectory since the GSK case transformed the compliance baseline. The market-supervision authorities treat payments to hospitals, physicians, and purchasing decision-makers as commercial bribery where the payment lacks genuine service substance. The "academic service fee" and "promotion fee" labels do not change the analysis if the underlying work is not real. In the VBP era, when margins no longer support large discretionary payments, the companies that survive an enforcement sweep are the ones that eliminated empty payment layers years before the inspector arrived.

The anti-monopoly dimension is frequently underestimated in channel redesigns. A manufacturer that controls distributor prices, allocates territories, or uses a pass-through entity to maintain resale-price control faces vertical monopoly-agreement enforcement under the Anti-Monopoly Law, and the pharma sector has been a named enforcement priority of the State Administration for Market Regulation (SAMR) in successive years.

The tax exposure in a redesigned channel is not limited to the entities that issue invoices. Under the special VAT invoice (fapiao) system, an invoice issued without a genuine goods or services transaction can be characterised as a false invoice, and the downstream recipients who take tax deductions or input-credit offsets on that invoice become part of the same enforcement picture. A manufacturer that sells to a paper layer, and a paper layer that invoices a hospital without moving goods, together create a chain that the State Taxation Administration reads as one scheme. The redesign must therefore be verified from the tax side: every invoice in the chain corresponds to a transaction with substance, and every input credit claimed downstream rests on a genuine supply.

Operational vulnerabilities and transactional pitfalls#

The redesign fails in predictable ways:

• The paper CSO: a sales-service organisation (CSO) is created with a name, a bank account, and invoices, but no real people performing promotion, no approved materials, and no evidence of service delivery. The CSO invoices are the first thing an inspection matches against service evidence.
• The empty layer: an intermediate distributor is kept in the chain to preserve old relationships, but it never touches the product. Its invoices contradict its logistics records, and the fapiao chain no longer matches the physical flow.
• Promotion without substance: real people are engaged, but their work is undocumented — no call reports, no approved promotional materials, no records of which hospitals they visited or which products they promoted. An engagement without a paper trail is treated as a payment without a purpose.
• Tender supply duties vs commercial selling: VBP contracts allocate tender supply volumes, but the company continues to sell commercially through other channels, and no written document separates the two obligations. When volumes are compared, the discrepancy looks like diversion.
• Relationship-maintenance payments: the budget line that pays "for relationship maintenance" survives the redesign. Whatever it is called, it is a payment with no performance, and it is the most direct evidence of commercial bribery on the file.

Distribution-channel files from Guangzhou#

In my healthcare-distribution practice in Guangzhou, the VBP-and-Two-Invoice redesign arrives on my desk as a commercial exercise wearing a legal costume: the company has already decided to “restructure the channel”, and the first question is whether the new structure survives inspection. The recurring failures are the ones this article maps. The paper CSO — a sales-service organisation with a name, a bank account and invoices, but no real people performing promotion, no approved materials and no evidence of service delivery — is the first thing the inspection matches against service evidence, and the invoice without the substance is the tax finding. The empty distributor layer kept in the chain to preserve old relationships is the second: if a layer cannot demonstrate physical handling of the product, it is deleted, and the deletion is what the regulator verifies against the logistics records. The promotion-rebuild is the third: under the Two-Invoice System the promotion function must move to a real service provider with real contracts, real delivery records and real payment trails, and a budget line for “relationship maintenance” that survives the redesign is the inspection target. The design principle I apply is simple: make logistics match invoices, make promotion match evidence, and make every layer in the chain demonstrable on the documents. The company that kills the paper layers itself controls the timeline; the company that waits for the inspector discovers the timeline the inspector sets.

Strategic compliance roadmap and action plan#

A defensible channel redesign under VBP and the Two-Invoice System runs on five principles:

1. Make logistics match invoices: every invoicing layer in the chain must have physical substance — product title transfers with real movement, warehouse records match the fapiao chain, and the logistics provider is documented. If a layer cannot demonstrate physical handling, it is deleted.
2. Rebuild promotion with real substance: where promotion is needed, engage real people with real work — approved materials, documented hospital interactions, and verifiable reports. Where promotion is not needed, pay nothing. The test is not what the entity is called; it is what work was performed.
3. Allocate tender vs commercial duties in writing: the tender supply contract and the commercial distribution arrangement are documented separately, with clear written allocation of volumes, geographies, and responsibilities. The written allocation is the evidence that separates VBP compliance from diversion.
4. Kill empty layers and stop relationship payments: eliminate every entity that exists only to move invoices or maintain access, and eliminate every payment that lacks documented performance. The savings are not a loss; they are the removal of legal risk.
5. Pair the redesign with the contract heat-map and anti-corruption file review: the channel redesign, the VBP contract review, and the anti-corruption audit are run in the same programme, not in sequential years. Each is a lens on the same set of commercial relationships, and the evidence assembled for one protects the others.

After the redesign, verify the new channel with a documented compliance review: sample transactions across the chain, match invoices to logistics records, confirm that every payment corresponds to performed work with evidence, and archive the review. The file is the defence.

The redesign should also anticipate the anti-monopoly dimension of channel control. After the channel is simplified, a manufacturer that imposes resale prices, allocates hospital accounts to specific distributors, or uses exclusive arrangements to control the downstream market may attract vertical-restraint scrutiny under the Anti-Monopoly Law, and the pharma and medical-device sectors have been named enforcement priorities. The compliance review of the redesigned channel therefore includes a vertical-restraint assessment: the distribution agreements are screened for minimum resale price maintenance, territorial allocations, and exclusivity clauses that cannot be justified on efficiency grounds. A channel that is clean on invoices but restrictive on competition has merely moved the risk from the tax file to the competition file.

What not to do#

Do not create a pass-through entity to preserve margins — the invoice machine is the inspection target. Do not keep an empty distributor layer because the general manager is old friends with its owner. Do not pay for promotion that cannot be evidenced, and do not let a budget line for "relationship maintenance" survive a redesign. The Two-Invoice System was designed to make the paper layers die; the company that kills them voluntarily chooses the file it will defend.

The channel review should run on a defined cadence — annually, and immediately after any VBP award, product launch, or distributor change — so that the redesigned structure stays aligned with the invoices, the logistics, and the anti-corruption file as the market evolves.

Read next: VBP disputes · Anti-corruption · Device distribution

Cluster: Life sciences legal hub · Life sciences blog