WWW.LEHMANBROWN.COM
Doing business in China
Russell Brown FCMA
Managing Partner, LehmanBrown
International Accountants
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London (Sales) Macau (Assoc)
Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港 Mongolia 蒙古
London (Sales) Macau (Assoc)
Geograhpical region of People’s Republic of
China
•
China is a vast country, though its population is 1.3billion, each province is in a different state
of development. Therefore disposable income is different and consequently the market for
products.
•
Taiwan is part of China, one country two systems.
•
Hong Kong and Macau are Special Administrative Regions (SARs).
•
Tibet is an Autonomous Region.
•
China has 29 provinces, special regions and municipal cities.
•
China has many different minorities, the largest being Han.
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Know Your Government Agencies
NDRC-National Development and Reform Commission
CSRC-China Securities Regulatory Commission
MOFCOM-Ministry of Commerce
SAFE-State Administration of Foreign Exchange
SAIC-State Administration for Industry and Commerce (also known as AIC)
SASAC-State Asset Supervision and Administration Commission
SAT-State Administration of Taxation
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Contents
1.
Types of legal entities and operations in China
2.
Corporate considerations
3.
Tax environment
4.
Areas of risk doing business in China
5.
The state of financial records
6.
The Accounting system
7.
Transfer pricing
8.
Foreign currency repatriation
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There are a number of different operating
structures in China, depending on business
strategy and capital
Types of legal entity available to foreign enterprises in China:
China Holding Company (“CHC”):
•
Min. asset value US$30m within 2 years, total investment within 5 years
•
Can make strategic RMB investments into subsidiaries.
•
Can carry out HQ functions and oncharge to subsidiaries
•
If CHC has RHQ status, can provide leasing or financing on own account
Wholly Foreign Owned Enterprise (“WFOE”) or Foreign Invested Commercial Enterprise (“FICE”):
•
100% shares owned by foreign parties, offshore or holding companies. Different industries
have different registered capital (equity and investment requirements)
Equity Joint Venture (“EJV”):
•
E.g. 70% equity, 70% profit.
Cooperative Joint Venture (“CJV”):
•
E.g. 50% equity, 80% profit. Contract can include many things, therefore flexible.
Representative Office (“RO”):
•
Like an overseas branch, although not allowed to conduct business, only allowed to provide
sales, marketing and support services.
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Contact manufacturing
An alternative to establishing own entity is to establish a relationship via contract
Manufacturing Contract:
•
Can incorporate into contract conditions, e.g. quality checks, intellectual property.
•
Is registered under Chinese law and therefore enforceable.
•
Does not require any capital investment
•
Can have contract specify requirement for adhoc independent audit
Cooperation Agreement:
•
Establish cooperation with Chinese entity
•
Set up bank account under their name, with independent control by accounting firm
•
Does not require any capital investment, not tied to partner firm if things do not work out
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Industry segmentation
Industries are split into the following categories:
1)
Prohibited – this means no foreign investor allowed. E.g. Media, Oil and Gas field ownership. In such
industries it is common for foreign investors to establish entities that can provide services to Chinese
owners, or to have companies under nominee shareholding, or piggy back someone's license.
2)
Restricted – Joint Venture only. E.g. Recruitment (maximum foreign ownership is 49%). If a foreign firm
wishes to have 100% ownership and control then use of nominees.
3)
Encouraged – Can be WFOE or JV, and tax concessions can be obtained.
4)
Conventional – Can be WFOE or JV, but no or limited local tax concessions.
For tax concessions, an entity must be classified as a Foreign Invested Enterprise (FIE). To be classified as an
FIE the foreign investment much be 25% or greater.
The are no laws in relation to nominees and use of, therefore though provided above, this actually just refers to
someone or something owns shares on behalf of foreign investor and there being a contractual
relationship in place in this regards.
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Main Forms of Business Establishment
Wholly
Foreign Owned
Enterprises (WFOE)
Joint Ventures
Companies
Equity JV
Companies (EJV)
Representative
Office (RO)
Foreign Investment
Companies
Limited by Shares
Purchase of shares
in Chinese
Share Companies
Contractual JV
Companies (CJV)
Market entry as
supplier/contractor
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WWW.LEHMANBROWN.COM
Contents
1.
Types of legal entities and operations in China
2.
Corporate considerations
3.
Tax environment
4.
Areas of risk doing business in China
5.
The state of financial records
6.
The Accounting system
7.
Transfer pricing
8.
Foreign currency repatriation
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Corporate considerations…………..
Choosing and maintaining the right structure involves……………….
Regulations
In House
Transfer Pricing - docs
Accounting Regulations
Service Contracts - Offshore
Taxation Regulations
FOREX Regulations
Transfer Pricing Reviews
???
Internal Control and Review
Rules and Regulations
Taxation Reviews
Accounting Policies
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Companies should review their operating
structure and strategies in light of the
industry regulations
• Manufacturers:

Impact of reduced customs duty on imported raw material (sourcing opportunities)

Need to change holding company (WHT implications on dividends, interest etc)

Buying out Chinese partners in existing JV’s
• Traders:

Ability to set up 100% owned trading companies from Dec 2004

Lowering of equity thresholds from US$150k-US$200k to RMB500k

Can establish anywhere in the country, not just in a trade zone
• Service Providers:

WFOE structures possible? Upgrading Rep Offices to WFOE?

Expansion of current approved business scope
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Contents
1.
Types of legal entities and operations in China
2.
Corporate considerations
3.
Tax environment
4.
WTO accession and tax concessions available
5.
Areas of risk doing business in China
6.
The state of financial records
7.
The Accounting system
8.
Transfer pricing
9.
Foreign currency repatriation
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The current tax system in China is regulated
by the SAT, but taxes are still collected at
both state and local levels
China is a Civil Law country:

Rules are codified

Judges cannot set rules or principles

Lower courts not bound by higher court decisions

Set by State Administration of Taxation (“SAT”) – power of a ministry

Governed by State Council (“SC”) which is under the National People’s
Congress( “NPC”)

Responsible for collection of state tax

Responsible for collecting provincial tax

Reports to the SAT
Taxation rules:
State Tax Bureau:
Local Tax Bureau
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Taxation and WTO accession

China’s tax system experiences great changes in 1994, governing at boosting the country’s economic
development and encouraging foreign investment.

Rapid economic development has created a necessity for the tax system to grow and adapt.

New laws are continually being implemented to replace outdated laws.

According to Commissioner of the State Administration of Taxation, one of the main tasks for the 11th
five-year plan is to carry out further and continued reform on the tax system.

China’s accession to WTO required changes in areas such as import duties. These changes are driving
other changes in order to maintain revenue balance.

Improved collection and management systems are being implemented
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Tightening of tax collection and crackdown
on fraud
•
Under WTO, import duties are declining, therefore revenue to be received.
•
The Government is therefore panicking a little as they need $$$’s. Olympics, Beijing
infrastructure enhancement, country development etc.
•
New directive by Government to bureaus:
•

Continue to crack down on fraud, using police and justice departments
for assistance.

Clamp down on IIT avoidance (annual E’ee filing now required).

Taxing branches at rate in location of operation (.e.g Shanghai 15%
tax, but branch in Beijing 33% tax)
Two groups targeted:
1.
Foreign companies
2.
Wealthy Chinese individuals and expatriates
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Tax concessions provided to foreign
companies (up to 31st December 2007)
Tax exemption/reduction
•
Production-oriented - exempt from corporate income tax for 2 years and 3 years at 50% tax rate,
from time of cumulative profit.
Industry based incentives
•
Export-oriented enterprises - If the export value of an FIE is more than 70% of its output, a
50% reduction is available in calculating the tax payable.
•
Encourage industries and Advanced technology enterprises taxed at the rate of 15%.
Geographical based incentives
•
Special Economic Zones (“SEZs”) - All FIEs in SEZs should pay tax at the rate of 15%.
•
Coastal Open Economic Zones (“COEZs”) - FIEs established in the COEZs may pay tax at
the rate of 24%.
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Taxation from 1st January 2008
•
The new regulation has been approved, the interpretation for implementation is currently
taking place, and is still to be finalised.
•
Current country wide tax (excluding economic zones is 33%. This will reduce to 25%.
•
Some special zones will remain at 15%.
•
Some industries will remain at 15%.
•
Tax holidays will be grandfathered for a period of time.
•
New tax holidays will be granted to encouraged industries, with a catelog of these
updated annually.
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Contents
1.
Types of legal entities and operations in China
2.
Corporate considerations
3.
Tax environment
4.
Areas of risk doing business in China
5.
The state of financial records
6.
The Accounting system
7.
Transfer pricing
8.
Foreign currency repatriation
Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港 Mongolia 蒙古
London (Sales) Macau (Assoc)
Areas of risk for investors in China
Keys areas:
- Market Risk – Competition, innovations, price
- Human Risk – Stealing, fraud, unions
- Economic Risk – Government Policy changes, economics, investigations
- Management Risk – Incompetence, nepotism and influences.
- Business Risk – Internal controls, suppliers, logistics.
- Legal Risk – Ownership, scope of business, asset ownership, IP.
Each business’s risk can be broken down into the above areas
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Risks and barriers of market-entry
in China (in % of high risk)
• Political instability
• Currency risk
• Cultural barriers
• Constitutional Documents,
Government Approvals and
Operating Licenses
• Company Structure
• 2 to 4 sets of Accounting
books
Language
Culture
35
32
30
25
23
25
18
20
15
10
5
0
15
10 10
7
Market Knowhow
Political
instability
Currency
Tax Exposure
Off-Book
Transactions
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Business Fraud
Reasons behind the business fraud environment in the PRC:
•
Corporate Governance is often poor
•
Lack of internal controls
•
The Chinese legal system has significant grey areas which can be exploited
•
China currently has large amounts of speculative capital flowing around the country,
particularly related to booming property investment
•
The ‘get rich quick’ attitude has emerged with booming economic growth
•
Low salary earned by employees. I “disserve” a better treatment. Steeling from a
company is not like steeling an individual. Companies have money!
•
Language barrier big problem for foreign enterprises. Very often the CFO or the
“auditor” must rely on the translation of the person who does the fraud.
•
Respect of the authority level, NEVER challenge the boss about what he’s doing…
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Contents
1.
Types of legal entities and operations in China
2.
Corporate considerations
3.
Tax environment
4.
Areas of risk doing business in China
5.
The state of financial records
6.
The Accounting system
7.
Transfer pricing
8.
Foreign currency repatriation
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Business Due Diligence
Typical reviews of companies involve financial due diligence.
Weaknesses in developing economy:
- There are usually more than one set of books.
- Financial information does not take into account accuracy of future
projections.
- Non-financial information is just as important, such as competency of
management.
Investors should perform business due diligence addressing all areas
of risk as well as financial (audit)
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Poor transparency and unreliable
financial information
State Owned Enterprises require audit:
- Usually report cannot be trusted.
- Focus areas of due diligence are related party transactions.
- Purchaser should consider asset purchase with selective employee transfer
Domestic Companies normally do not require auditing, unless they are loss making or listed:
- Financials prepared for Taxation Bureau and Annual Inspection
- Domestic company accounting rules and tax rules different, forcing two sets of books
- Therefore, reconstruction of books needs before due diligence
- Purchaser could consider purchase of company
- Post purchase, need immediate internal and financial controls
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Contents
1.
Types of legal entities and operations in China
2.
Corporate considerations
3.
Tax environment
4.
Areas of risk doing business in China
5.
The state of financial records
6.
The Accounting system
7.
Transfer pricing
8.
Foreign currency repatriation
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The Chinese accounting system is
also going through huge ideological
changes at the moment
New Accounting System
Comprehensive
Reporting Framework
Definitions
Transparency
Prudence
Standards
Concepts
Consistency
Presentation
Completeness
• The “New System” defines certain accounting fundamentals such as consistency, timeliness,
understandability, accrual basis, matching, materiality … etc.
• China moving towards adopting International Standards for accounting and reporting.
• Has 39 new regulations effect from 2007, bringing in line with HK GAAP (basically IFRS)
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Statutory filing in China for foreign
companies
• Quarterly for profit and loss, balance sheet and cashflow to Tax
Bureau.
• Monthly to Ministry of Statistics in some locations and for some industries.
• Annual Audit accounts to be registered with:
- Tax bureau
- Administration of Industry and Commerce (for biz license renew)
- Ministry of Commerce
It is not possible to obtain a copy of filed reports from Government
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Contents
1.
Types of legal entities and operations in China
2.
Corporate considerations
3.
Tax environment
4.
Areas of risk doing business in China
5.
The state of financial records
6.
The Accounting system
7.
Transfer pricing
8.
Foreign currency repatriation
Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港 Mongolia 蒙古
London (Sales) Macau (Assoc)
Why engage in Transfer Pricing in China?
Group Profits
Profit Repatriation
Transfer Pricing
Allocation of corporate costs
Business
Sense
Ipso Facto sale of goods
Tax Efficiencies
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Regular Transfer Pricing Reviews
• Tax authority has the right to make reasonable adjustments to the pricing of any transactions deemed not
to be conducted at “arms length”
• Transfer pricing review will be targeting companies with:

Continuing losses (greater than 2 years)

Marginal profits or losses with expanded operations

Erratic Profits

Lower than average profit margins

Payment of unreasonable fees

Sudden drop in profits after tax holiday
• Circular 49 – Companies with interco transactions greater than US$12k in a year
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Types of Transfer Pricing Arrangements
Purchase of raw
materials
Purchase of products
Sales of products
Services provided
offshore on behalf
of onshore
Consulting agreements
Transfer Pricing
Royalties agreements
Subsidiary to holding
company
Services provided
onshore on behalf
of offshore
Intellectual property
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Contents
1.
Types of legal entities and operations in China
2.
Corporate considerations
3.
Tax environment
4.
Areas of risk doing business in China
5.
The state of financial records
6.
The Accounting system
7.
Transfer pricing
8.
Foreign currency repatriation
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Foreign Exchange Repatriation
• Foreign Exchange (Forex) is strictly regulated in China by SAFE regulations.
• Transactions up to US$200k without prior approval from SAFE okay, and below US$50k without tax
bureau approval at time of payment (need to obtain later)
• Foreign companies can transfer out for product purchase and services, just need the correct paperwork
• It is easier than before to get money out of country
• For companies not in China but needing to receive revenue in RMB, can use escrow services.
• Escrow provider will arrange transfer less applicable taxes.
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Importance of documentation
and tax
•
All transfers from China overseas need tax approval / clearance.
•
Contract needs to be clear for services, whether provided offshore, or both.
•
If service contracts not clear, Tax Bureau assumes 60% onshore.
• Onshore services transfer abroad subject to 5% biz tax, unless project over 183 days, then can also be
subject to 10% withholding tax (or can be classified as PR, therefore taxed on deemed profit).
• Royalties are subject to 5% business tax followed by 10% withholding tax, total 14.5%, 9.5% credit can be
obtained in home country.
• WHT can be claimed back in home country where tax treaty in place
•
Generally no tax on dividends, and can declare at any time
• China has tax treaties with over 70 countries and is an observer member of Organisation for Economic CoOperation and Development (OECD)
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Any questions?
Russell Brown FCMA
Beijing
Harby Janagol FCMA
London
Tel: +86 10 8532 1720
Tel: 020 8755 5829
Fax: +86 10 6532 3270
Fax: 0871 221 6102
rbrown@lehmanbrown.com
hjanagol@lehmanbrown.com
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Any questions?
Russell Brown /
Dickson Leung
Beijing
Tel: +86 10 8532 1720
Fax: +86 10 6532 3270
beijing@lehmanbrown.com
James Chang /
Borys Priadko
Shanghai
Tel: +86 21 6288 1635
Fax: + 86 21 6288 1636
shanghai@lehmanbrown.com
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