1. Doing business in China Managing Partner, LehmanBrown
Doing business in China
Russell Brown FCMA
Managing Partner, LehmanBrown
International Accountants

3. 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.

4. 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
The worst department is generally SAFE, due the restrictions in getting funds in and out of the country, therefore companies need to carefully plan.
SAT are getting quite organizaed, and therefore most firms focus and keep them happy, the same of with other countries.
Ministry of Commerce approved investment, however it is SAIC that issues the business licenses and needs regular filings and renewals.

5. Contents Types of legal entities and operations in China
Contents
Types of legal entities and operations in China
Corporate considerations
Tax environment
Areas of risk doing business in China
The state of financial records
The Accounting system
Transfer pricing
Foreign currency repatriation

6. Types of legal entity available to foreign enterprises in China:
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.
E.g. of Holding Companies, Proctor & Gamble, Siemens, Unilever, General Motors
Representative offices have 4 sub-types for tax:
1st – Can actually receive revenue, but need to get the tax bureau to issue receipt and pay tax. This is in contrast with SAIC regarding sales role only, however SAT holds more power. Consulting firms are usually 1st category.
2nd – Cost plus basis, which is the most common, e.g. sourcing companies.
3rd – Deemed profit basis, usually architecture firms, and anyone that does not fit in 1st or 2nd
4th – Tax exempt, e.g. not for profits, and offices selling inbound self made products, the later is difficult to obtain though

7. 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
Manufacturing contract can be similar to a JV contract, however there is no legal registered entity and therefore investment. Equipment can be imported tax and duty free to a contractor, as long as all goods made with this equipment are for export.
Cooperation agreements are used in restricted industries, e.g. accounting, legal, oil and gas, meda.

8. Industry segmentation
Industries are split into the following categories:
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.
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.
Encouraged – Can be WFOE or JV, and tax concessions can be obtained.
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.

9. Main Forms of Business Establishment
Wholly
Foreign Owned
Enterprises (WFOE)
Joint Ventures
Companies
Foreign Investment
Companies
Limited by Shares
Purchase of shares
in Chinese
Share Companies
Equity JV
Companies (EJV)
Contractual JV
Companies (CJV)
Representative
Office (RO)
Market entry as
supplier/contractor

10. Contents Types of legal entities and operations in China
Contents
Types of legal entities and operations in China
Corporate considerations
Tax environment
Areas of risk doing business in China
The state of financial records
The Accounting system
Transfer pricing
Foreign currency repatriation

11. ??? Choosing and maintaining the right structure involves……………….
Corporate considerations…………..
Choosing and maintaining the right structure involves……………….
Regulations
In House
Transfer Pricing - docs
Transfer Pricing Reviews
Accounting Regulations
???
Internal Control and Review
Service Contracts - Offshore
Rules and Regulations
Before entering China, first think about objectives, where you want to receive cash and where and how you wish to pay taxes, what royalty agreements are to be in place, cashflow requirements etc. Better to spend time first, than corrective action later.
Taxation Regulations
Taxation Reviews
FOREX Regulations
Accounting Policies

12. 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

13. Contents Types of legal entities and operations in China
Contents
Types of legal entities and operations in China
Corporate considerations
Tax environment
WTO accession and tax concessions available
Areas of risk doing business in China
The state of financial records
The Accounting system
Transfer pricing
Foreign currency repatriation

14. 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
Taxation rules:
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”)
State Tax Bureau:
Responsible for collection of state tax
Local Tax Bureau
Responsible for collecting provincial tax
Reports to the SAT

15. 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

16. 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:
Foreign companies
Wealthy Chinese individuals and expatriates
Two examples:
A Swiss company had not paid IIT, they had 7 expatriates. The accountant had a smaller pay rise than expected, and therefore decided to take matters into own hands and hand over documents to tax bureau, resulting in 6 being expelled from the country and 1 being arrested and kept until the mother company paid the tax.
Malaysian tire maker. They imported rubber at a lower price than market price, and charged the difference as R&D. Customs decided that they were deliberately trying to avoid VAT and import duties, and therefore raided the offices, took General Manager, Accountant in Cashier in custody. The later two were released next day, GM kept for a week, until company could start negotiations to pay tax. Bank accounts were frozen for the amount of deemed underpayment of tax.

17. 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%.
Where you locate is linked as much to tax strategy as to suppliers and market for goods, since logistics in China is good.
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%.

18. 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.

19. Contents Types of legal entities and operations in China
Contents
Types of legal entities and operations in China
Corporate considerations
Tax environment
Areas of risk doing business in China
The state of financial records
The Accounting system
Transfer pricing
Foreign currency repatriation

20. Market Risk – Competition, innovations, price
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
Competition – Ikea opened new store, within a month there were many lookalike Ikeas around the corner.
Price – Chinese work of different margins to many companies, a listed US company has to make margin, a Chinese privately held firm does not.
Fraud – Large international paper manufacturer has fraud issues with HR department

21. Political instability Currency risk Cultural barriers
Constitutional Documents, Government Approvals and Operating Licenses
Company Structure
2 to 4 sets of Accounting books
Source: LehmanBrown

22. 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…

23. Contents Types of legal entities and operations in China
Contents
Types of legal entities and operations in China
Corporate considerations
Tax environment
Areas of risk doing business in China
The state of financial records
The Accounting system
Transfer pricing
Foreign currency repatriation

24. Typical reviews of companies involve financial due diligence.
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)

25. 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

26. Contents Types of legal entities and operations in China
Contents
Types of legal entities and operations in China
Corporate considerations
Tax environment
Areas of risk doing business in China
The state of financial records
The Accounting system
Transfer pricing
Foreign currency repatriation

27. Comprehensive Reporting Framework
The Chinese accounting system is also going through huge ideological changes at the moment
Comprehensive Reporting Framework
New Accounting System
Standards
Concepts
Definitions
Presentation
Transparency
Prudence
Consistency
Completeness
Transparency is something not common in China of past. The tax bureau and other Government bureaus are very keen on this for obvious reasons.
The idea of Prudence and allowing companies to apply accounting standards in line with their business (I.e. not rules based) is becoming more accepted. This obviously requires higher degrees of transparency however.
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)

28. Annual Audit accounts to be registered with: Tax bureau
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

29. Contents Types of legal entities and operations in China
Contents
Types of legal entities and operations in China
Corporate considerations
Tax environment
Areas of risk doing business in China
The state of financial records
The Accounting system
Transfer pricing
Foreign currency repatriation

30. Business Sense Why engage in Transfer Pricing in China?
Profit Repatriation
Ipso Facto sale of goods
Allocation of corporate costs
Group Profits
Tax Efficiencies
Transfer Pricing
Business Sense

31. 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

32. Transfer Pricing Types of Transfer Pricing Arrangements
Sales of products
Consulting agreements
Purchase of raw materials
Services provided offshore on behalf of onshore
Intellectual property
Subsidiary to holding company
Transfer Pricing
Purchase of products
Royalties agreements
Services provided onshore on behalf of offshore

33. Contents Types of legal entities and operations in China
Contents
Types of legal entities and operations in China
Corporate considerations
Tax environment
Areas of risk doing business in China
The state of financial records
The Accounting system
Transfer pricing
Foreign currency repatriation

34. 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.

35. 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 Co-Operation and Development (OECD)

36. Any questions? Harby Janagol FCMA Russell Brown FCMA London Beijing
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Russell Brown FCMA
Beijing
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37. James Chang / Borys Priadko Russell Brown / Dickson Leung
Any questions?
James Chang / Borys Priadko
Shanghai
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Fax:
Russell Brown / Dickson Leung
Beijing
Tel:
Fax: