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WWW.LEHMANBROWN.COM
Doing business in China
Russell Brown FCMA Managing Partner,
LehmanBrown International Accountants
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(No Transcript)
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Geograhpical region of Peoples 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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WWW.LEHMANBROWN.COM
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

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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 US30m 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
• 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.

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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)
Market entry as supplier/contractor
Representative Office (RO)
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WWW.LEHMANBROWN.COM
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

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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
Taxation Regulations
Taxation Reviews
Accounting Policies
FOREX Regulations
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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 JVs

• Traders
• Ability to set up 100 owned trading companies
  from Dec 2004
• Lowering of equity thresholds from
  US150k-US200k 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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WWW.LEHMANBROWN.COM
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

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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
• Taxation rules
• Set by State Administration of Taxation (SAT)
  power of a ministry
• Governed by State Council (SC) which is under
  the National Peoples Congress( NPC)
• State Tax Bureau
• Responsible for collection of state tax
• Local Tax Bureau
• Responsible for collecting provincial tax
• Reports to the SAT

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Taxation and WTO accession

• Chinas tax system experiences great changes in
  1994, governing at boosting the countrys
  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.
• Chinas 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 Eee 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

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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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WWW.LEHMANBROWN.COM
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

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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 businesss risk can be broken down into the
  above areas

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

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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 hes doing

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WWW.LEHMANBROWN.COM
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

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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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WWW.LEHMANBROWN.COM
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

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The Chinese accounting system is also going
through huge ideological changes at the moment
Comprehensive Reporting Framework
New Accounting System
Transparency
Prudence
Consistency
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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WWW.LEHMANBROWN.COM
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

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Why engage in Transfer Pricing in China?
Business Sense
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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 US12k in a year

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Types of Transfer Pricing Arrangements
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WWW.LEHMANBROWN.COM
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

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Foreign Exchange Repatriation

• Foreign Exchange (Forex) is strictly regulated
  in China by SAFE regulations.
• Transactions up to US200k without prior
  approval from SAFE okay, and below US50k 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 Co-Operation and Development (OECD)

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Any questions?
Harby Janagol FCMA London Tel [phone] Fax
0871 221 6102 hjanagol_at_lehmanbrown.com
Russell Brown FCMA Beijing Tel [phone]
Fax [phone] rbrown_at_lehmanbrown.com
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Any questions?
James Chang / Borys Priadko Shanghai Tel 86 21
6288 1635 Fax [phone] shanghai_at_lehman
brown.com
Russell Brown / Dickson Leung Beijing Tel 86 10
8532 1720 Fax [phone] beijing_at_lehmanbr
own.com
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