3Geograhpical 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.
4Know Your Government Agencies NDRC-National Development and Reform CommissionCSRC-China Securities Regulatory CommissionMOFCOM-Ministry of CommerceSAFE-State Administration of Foreign ExchangeSAIC-State Administration for Industry and Commerce (also known as AIC)SASAC-State Asset Supervision and Administration CommissionSAT-State Administration of TaxationThe 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.
5Contents Types of legal entities and operations in China ContentsTypes of legal entities and operations in ChinaCorporate considerationsTax environmentAreas of risk doing business in ChinaThe state of financial recordsThe Accounting systemTransfer pricingForeign currency repatriation
6Types of legal entity available to foreign enterprises in China: There are a number of different operating structures in China, depending on business strategy and capitalTypes 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 yearsCan make strategic RMB investments into subsidiaries.Can carry out HQ functions and oncharge to subsidiariesIf CHC has RHQ status, can provide leasing or financing on own accountWholly 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 MotorsRepresentative 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 2nd4th – Tax exempt, e.g. not for profits, and offices selling inbound self made products, the later is difficult to obtain though
7Contact manufacturing An alternative to establishing own entity is to establish a relationship via contractManufacturing 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 investmentCan have contract specify requirement for adhoc independent auditCooperation Agreement:Establish cooperation with Chinese entitySet up bank account under their name, with independent control by accounting firmDoes not require any capital investment, not tied to partner firm if things do not work outManufacturing 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.
8Industry 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.
9Main Forms of Business Establishment WhollyForeign OwnedEnterprises (WFOE)Joint VenturesCompaniesForeign InvestmentCompaniesLimited by SharesPurchase of sharesin ChineseShare CompaniesEquity JVCompanies (EJV)Contractual JVCompanies (CJV)RepresentativeOffice (RO)Market entry assupplier/contractor
10Contents Types of legal entities and operations in China ContentsTypes of legal entities and operations in ChinaCorporate considerationsTax environmentAreas of risk doing business in ChinaThe state of financial recordsThe Accounting systemTransfer pricingForeign currency repatriation
11??? Choosing and maintaining the right structure involves………………. Corporate considerations…………..Choosing and maintaining the right structure involves……………….RegulationsIn HouseTransfer Pricing - docsTransfer Pricing ReviewsAccounting Regulations???Internal Control and ReviewService Contracts - OffshoreRules and RegulationsBefore 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 RegulationsTaxation ReviewsFOREX RegulationsAccounting Policies
12Companies should review their operating structure and strategies in light of the industry regulationsManufacturers: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’sTraders:Ability to set up 100% owned trading companies from Dec 2004Lowering of equity thresholds from US$150k-US$200k to RMB500kCan establish anywhere in the country, not just in a trade zoneService Providers:WFOE structures possible? Upgrading Rep Offices to WFOE?Expansion of current approved business scope
13Contents Types of legal entities and operations in China ContentsTypes of legal entities and operations in ChinaCorporate considerationsTax environmentWTO accession and tax concessions availableAreas of risk doing business in ChinaThe state of financial recordsThe Accounting systemTransfer pricingForeign currency repatriation
14The current tax system in China is regulated by the SAT, but taxes are still collected at both state and local levelsChina is a Civil Law country:Rules are codifiedJudges cannot set rules or principlesLower courts not bound by higher court decisionsTaxation rules:Set by State Administration of Taxation (“SAT”) – power of a ministryGoverned by State Council (“SC”) which is under the National People’s Congress( “NPC”)State Tax Bureau:Responsible for collection of state taxLocal Tax BureauResponsible for collecting provincial taxReports to the SAT
15Taxation 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
16Tightening 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 companiesWealthy Chinese individuals and expatriatesTwo 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.
17Tax concessions provided to foreign companies (up to 31st December 2007) Tax exemption/reductionProduction-oriented - exempt from corporate income tax for 2 years and 3 years at 50% tax rate, from time of cumulative profit.Industry based incentivesExport-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 incentivesSpecial 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%.
18Taxation 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.
19Contents Types of legal entities and operations in China ContentsTypes of legal entities and operations in ChinaCorporate considerationsTax environmentAreas of risk doing business in ChinaThe state of financial recordsThe Accounting systemTransfer pricingForeign currency repatriation
20Market Risk – Competition, innovations, price Areas of risk for investors in ChinaKeys areas:Market Risk – Competition, innovations, priceHuman Risk – Stealing, fraud, unionsEconomic Risk – Government Policy changes, economics, investigationsManagement 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 areasCompetition – 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
21Political instability Currency risk Cultural barriers Constitutional Documents, Government Approvals and Operating LicensesCompany Structure2 to 4 sets of Accounting booksSource: LehmanBrown
22Business FraudReasons behind the business fraud environment in the PRC:Corporate Governance is often poorLack of internal controlsThe Chinese legal system has significant grey areas which can be exploitedChina currently has large amounts of speculative capital flowing around the country, particularly related to booming property investmentThe ‘get rich quick’ attitude has emerged with booming economic growthLow 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…
23Contents Types of legal entities and operations in China ContentsTypes of legal entities and operations in ChinaCorporate considerationsTax environmentAreas of risk doing business in ChinaThe state of financial recordsThe Accounting systemTransfer pricingForeign currency repatriation
24Typical reviews of companies involve financial due diligence. Business Due DiligenceTypical 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)
25Poor 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 transferDomestic Companies normally do not require auditing, unless they are loss making or listed:Financials prepared for Taxation Bureau and Annual InspectionDomestic company accounting rules and tax rules different, forcing two sets of booksTherefore, reconstruction of books needs before due diligencePurchaser could consider purchase of companyPost purchase, need immediate internal and financial controls
26Contents Types of legal entities and operations in China ContentsTypes of legal entities and operations in ChinaCorporate considerationsTax environmentAreas of risk doing business in ChinaThe state of financial recordsThe Accounting systemTransfer pricingForeign currency repatriation
27Comprehensive Reporting Framework The Chinese accounting system is also going through huge ideological changes at the momentComprehensive Reporting FrameworkNew Accounting SystemStandardsConceptsDefinitionsPresentationTransparencyPrudenceConsistencyCompletenessTransparency 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)
28Annual Audit accounts to be registered with: Tax bureau Statutory filing in China for foreign companiesQuarterly 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 bureauAdministration of Industry and Commerce (for biz license renew)Ministry of CommerceIt is not possible to obtain a copy of filed reports from Government
29Contents Types of legal entities and operations in China ContentsTypes of legal entities and operations in ChinaCorporate considerationsTax environmentAreas of risk doing business in ChinaThe state of financial recordsThe Accounting systemTransfer pricingForeign currency repatriation
30Business Sense Why engage in Transfer Pricing in China? Profit RepatriationIpso Facto sale of goodsAllocation of corporate costsGroup ProfitsTax EfficienciesTransfer PricingBusiness Sense
31Regular 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 operationsErratic ProfitsLower than average profit marginsPayment of unreasonable feesSudden drop in profits after tax holidayCircular 49 – Companies with interco transactions greater than US$12k in a year
32Transfer Pricing Types of Transfer Pricing Arrangements Sales of productsConsulting agreementsPurchase of raw materialsServices provided offshore on behalf of onshoreIntellectual propertySubsidiary to holding companyTransfer PricingPurchase of productsRoyalties agreementsServices provided onshore on behalf of offshore
33Contents Types of legal entities and operations in China ContentsTypes of legal entities and operations in ChinaCorporate considerationsTax environmentAreas of risk doing business in ChinaThe state of financial recordsThe Accounting systemTransfer pricingForeign currency repatriation
34Foreign 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 paperworkIt is easier than before to get money out of countryFor companies not in China but needing to receive revenue in RMB, can use escrow services.Escrow provider will arrange transfer less applicable taxes.
35Importance 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 placeGenerally no tax on dividends, and can declare at any timeChina has tax treaties with over 70 countries and is an observer member of Organisation for Economic Co-Operation and Development (OECD)
36Any questions? Harby Janagol FCMA Russell Brown FCMA London Beijing Tel:Fax:Russell Brown FCMABeijingTel:Fax:
37James Chang / Borys Priadko Russell Brown / Dickson Leung Any questions?James Chang / Borys PriadkoShanghaiTel:Fax:Russell Brown / Dickson LeungBeijingTel:Fax: