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The ¡°two-invoice system¡± in the pharmaceutical industry requires that a drug manufacturer issue one invoice to the distributor and that the distributor issue another invoice to the medical institution.

On 27 May, the National Health Commission, along with 13 other departments, released the Key Work Points for Correcting Unhealthy Tendency in the Field of Purchase and Sale of Medicinal Products and Medical Treatment Services in 2024, which called for ¡°further improving the two-invoice system for drug procurement in public medical institutions, standardising drug distribution, and intensifying regulation and enforcement¡±.

Last July, the National Health Commission and five other departments issued the Key Tasks for Deepening the Medical and Healthcare System Reform in the Second Half of 2023, which also mentioned ¡°researching and improving policies related to the two-invoice system¡±.

This indicates that, despite the continued expansion of the national drug procurement pilot programme, regulating and improving the two-invoice system remains a clear requirement in China¡¯s current healthcare reform.

Practical implications

The main goal of the two-invoice system is to standardise drug distribution, reduce excessive price inflation and alleviate patients¡¯ medication costs. Entities involved in drug distribution are most affected by the two-invoice system, as it eliminates the need for intermediary companies and secondary distributors. Consequently, many distributors have adapted in various ways to survive or maintain profit margins.

Distributors transforming into logistics or service companies. In comparison with ordinary logistics, pharmaceutical logistics require higher standards for temperature control, cleanliness and quality management, along with a system for drug traceability.

Distributors meeting these conditions leverage their existing distribution networks to provide pharmaceutical logistics services for drug manufacturers, aligning with market demands. Manufacturers pay logistics fees to these logistics companies, entrusting them to deliver drugs to first-tier distributors without issuing sales invoices.

Contract sales organisations (CSOs) primarily provide specialised outsourcing services in sales and marketing for pharmaceutical manufacturers, including market research, promotion, channel design and end-point sales.

With the two-invoice system, manufacturers can outsource drug and medical device promotion to CSOs with established resources and channels. In this scenario, manufacturers receive value-added tax (VAT) invoices for services from CSOs, which can be used for input VAT deductions, reducing operational costs.

Manufacturers engaging in illegal high pricing and rebates. Because the two-invoice system reduces the number of profit opportunities in drug distribution, some pharmaceutical companies have resorted to high pricing and rebates to maintain their profit.

This involves manufacturers inflating the factory prices of drugs and issuing invoices at these higher prices, then cashing out rebates to distributors by fabricating various expenses, simultaneously obtaining VAT input invoices or cost invoices to reduce their VAT and corporate income tax burdens. However, the end-user drug prices remain high.

The execution of these back-end rebates often relies on fictitious CSO services. Besides violating rebate regulations and contravening the two-invoice system, this practice also entails legal risks such as issuing fake VAT invoices, engaging in commercial bribery and monopolising prices.

Regarding rebate recipients, it is common for distribution companies to act as both first-tier distributors and outsourced service providers or logistics companies for manufacturers, as well as to provide outsourcing services through affiliated companies or subsidiaries.

Compliance measures

Assessing authenticity and reasonableness. In the context of China¡¯s healthcare reform continuing to refine the two-invoice system, the authenticity and reasonableness of CSO company service fees will be under increased regulatory scrutiny. Authenticity must be based on actual business activities, while reasonableness requires examining the basis for fee calculations.

If service fees are solely tied to drug sales volume, and there are financial transactions or affiliations between distribution companies and CSO companies, the risk of being deemed non-compliant increases.

This could also lead to disputes over whether the fees are considered service fees or commissions, which involve the pre-tax deduction ratio limitation for commissions. Therefore, it is recommended that manufacturers link service fee pricing to service performance evaluations and conduct phased assessments of actual work results, and make payments accordingly.

Strengthening tax supervision and information management. Amid increasing tax regulation and the advancement of phase IV of the golden tax system (intelligent tax) in China, manufacturers should collaborate with distributors or CSOs that have high tax credit ratings and good tax compliance track records to avoid tax risks from their partners.

It is essential to ensure that invoices, funds, contracts and deliveries are consistent, corresponding and logically aligned. For intangible, variable and easily lost outsourcing services, companies should maintain a complete service evidence chain, manage financial documents carefully, and build information management systems covering all tax categories, upstream and downstream enterprises, and internal employee expense invoices. These systems should ensure that transactions match invoices and promptly identify any suspicious financial documents.

Medical device companies should update co-operation models based on pharmaceutical practices. In current healthcare reforms, the two-invoice system policy applies not only to drug procurement in public hospitals, but is also gradually extending to the medical device sector, particularly consumables.

In practice, bundled sales of medical devices are common: suppliers provide free medical equipment to medical institutions, which then must purchase related consumables from the supplier. This model can be seen as anti-competitive or involving improper donations.

As healthcare reforms deepen, the two-invoice system is likely to cover more medical devices related to consumables. Therefore, medical device companies should adopt innovative external co-operation models like those in the pharmaceutical industry.

They should carefully select distributors and conduct due diligence on potential partners¡¯ compliance. Preparing in advance will help ensure smooth adaptation to the expanding scope of the two-invoice system.

Jin Jing is a partner and Wu Jian is an associate at Blossom & Credit Law Firm