Doing Business in China

WWW.LEHMANBROWN.
COM
Doing business in China
Russell Brown FCMA

Managing Partner, LehmanBrown
International Accountants
Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

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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

Mongolia 蒙古
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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 Investment Purchase of shares

Joint Ventures
Foreign Owned Companies in Chinese
Companies
Enterprises (WFOE) Limited by Shares Share Companies
Equity JV Contractual JV
Companies (EJV) Companies (CJV)
Representative Market entry as

Office (RO) supplier/contractor

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Contents
3. Tax environment
7. Transfer pricing

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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
FOREX Regulations 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
3. Tax environment
4. WTO accession and tax concessions available
8. Transfer pricing

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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 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

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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
3. Tax environment
7. Transfer pricing

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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 business’s risk can be broken down into the above areas

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Risks and barriers of market-entry Language
in China (in % of high risk)
Culture
• Political instability
35 32 Market Know-
• Currency risk 30 how
25
• Cultural barriers 25 23 Political
• Constitutional Documents, 20 18 instability
15 Currency
Government Approvals and 15 10 10
Operating Licenses 10 7 Tax Exposure
• Company Structure 5
Off-Book
• 2 to 4 sets of Accounting books 0
Transactions
• 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 he’s doing…

Mongolia 蒙古
WWW.LEHMANBROWN.COM
Contents
3. Tax environment
7. Transfer pricing

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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

Mongolia 蒙古
WWW.LEHMANBROWN.COM
Contents
3. Tax environment
7. Transfer pricing

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The Chinese accounting system is
also going through huge ideological
changes at the moment
Comprehensive
New Accounting System
Reporting Framework
Definitions Transparency
Prudence
Concepts Standards
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

Mongolia 蒙古
WWW.LEHMANBROWN.COM
Contents
3. Tax environment
7. Transfer pricing

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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
Sales of products Purchase of products
Services provided
Consulting agreements offshore on behalf
Transfer Pricing of onshore
Services provided
Royalties agreements onshore on behalf
of offshore
Subsidiary to holding
Intellectual property
company

Mongolia 蒙古
WWW.LEHMANBROWN.COM
Contents
3. Tax environment
7. Transfer pricing

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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 Co-
Operation and Development (OECD)

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Any questions?
Russell Brown FCMA Harby Janagol FCMA

Beijing 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
WWW.LEHMANBROWN.COM

Mongolia 蒙古
Any questions?
Russell Brown / James Chang /

Dickson Leung Borys Priadko
Beijing Shanghai
Tel: +86 10 8532 1720 Tel: +86 21 6288 1635
Fax: +86 10 6532 3270 Fax: + 86 21 6288 1636

beijing@lehmanbrown.com shanghai@lehmanbrown.com
WWW.LEHMANBROWN.COM

Mongolia 蒙古

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WWW.LEHMANBROWN.

Russell Brown FCMA

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

• 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.

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

NDRC-National Development and Reform Commission

CSRC-China Securities Regulatory Commission

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

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

1. Types of legal entities and operations in China

4. Areas of risk doing business in China

5. The state of financial records

6. The Accounting system

8. Foreign currency repatriation

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

Types of legal entity available to foreign enterprises in China:

Equity Joint Venture (“EJV”):

Cooperative Joint Venture (“CJV”):

Representative Office (“RO”):

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

An alternative to establishing own entity is to establish a relationship via contract

• Is registered under Chinese law and therefore enforceable.

• Does not require any capital investment

• Can have contract specify requirement for adhoc independent audit

• Establish cooperation with Chinese entity

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

Industries are split into the following categories:

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.

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

Wholly Foreign Investment Purchase of shares

Representative Market entry as

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

1. Types of legal entities and operations in China

4. Areas of risk doing business in China

5. The state of financial records

6. The Accounting system

8. Foreign currency repatriation

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

Choosing and maintaining the right structure involves……………….

Transfer Pricing - docs Transfer Pricing Reviews

Accounting Regulations Internal Control and

Taxation Regulations Taxation Reviews

FOREX Regulations Accounting Policies

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

 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

 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

 WFOE structures possible? Upgrading Rep Offices to WFOE?

 Expansion of current approved business scope

Beijing 北京 Shanghai 上海 Shenzhen 深圳 Guangzhou 广州 Tianjin 天津 Hong Kong 香港

1. Types of legal entities and operations in China

4. WTO accession and tax concessions available