The rewards of doing business in China are immense but the risks are real. We asked two Grant Thornton experts to present their risk assessment on doing business in China
Stanley Chang, head of Global Business Risk Services at Grant Thornton International, says: “Businesses should be prepared for challenges in dealing with the government, as well as wider issues.” He presents eight business issues to consider.
1. Government control
An increasing number of strict regulations exist over the way business can be done in China. While all competitors are subject to the same laws and regulations, the enforcement of those compliance regulations may be different for many local competitors. In certain designated industries, for example, multinational companies are required to co-operate with local joint venture partners, which are generally selected by the Chinese government, and governmental orders may be redirected towards local competitors in the future.
2. Inconsistent interpretation of rules and regulations
The Chinese government has issued a number of laws and regulations relating to taxes, such as corporate income tax law and transfer pricing. However, certain detailed implementation guidelines for these laws and regulations are still not pronounced, even though the respective laws and regulations may have taken effect. In addition, local authorities retain the right to interpret existing laws and regulations, resulting in a lack of consistency between individual provinces and jurisdictions.
3. Concerns about intellectual property
China’s intellectual property laws would need to be updated in order for them to be in line with the intellectual property laws in many mature economies. In order to take action under the Chinese intellectual property laws, local registration of intellectual property in China is required. However, registration frequently requires provision of significant information about the intellectual property to the Chinese authorities.
4. Increased local competition
The Chinese government strongly promotes the evolution of strong local competitors in its key industries. The quality of products delivered by local competitors is rapidly increasing, requiring reaction in terms of innovation at the higher end of the market, as well as cost savings at the lower end of the market.
5. Lack of controls
Historically, businesses in China are not familiar with key concepts of internal control over financial reporting, since the finance function has not been seen as a key function in an organisation. Risks tend to be addressed on a reactive, not proactive, basis. If risks are being managed, a silo approach is often used.
6. Recruitment issues
There is a lack of skilled and well-trained employees, particularly in the areas of engineering and finance. Retention rates are low and some salaries (eg, engineering, finance) have witnessed double-digit growth and in certain areas are at the same levels as in mature markets. Due to governments trying to control housing prices via ‘hu-kou’ (residence registration), talent management will be more challenging in coming years. (For more on this issue, read Grant Thornton’s article: What’s your employment strategy for hiring in China?)
7. Little supply chain management
Effective supply chain management tools are missing in most companies in China due to a reliance on existing relationships. Corruption, bribery and fraud are issues, and raw material prices have surged over the past few years.
8. Opaque practices
Intertwined relationships are a common occurrence. Business perks are maximised, and in certain industries there are commission payments to agents and other third parties. Dealing with local joint venture partners can be tricky for multinational corporations.
Nick Farr, of Grant Thornton UK’s China Britain Services Group, adds two extra financial risk management considerations for businesses investing in China or repatriating profits back to the UK.
9. Putting money into China
The first surprise for UK companies that are considering investing in China is that it can take as long to get approval to put money into the country as it does to take it out, due to careful regulation of capital to manage currency speculation. As a result, cash flow needs to be planned well in advance – or risk Chinese operations being starved of cash, or the parent having to bear expenditure on behalf of its subsidiary.
There are also prescribed rules as to how funds can be injected with minimum capital requirements and prescribed debt-to-equity ratios.
10. Getting money out of China
Moving cash out of China can also be a slow process – it typically takes around three to four months to move funds. If not done correctly, cash can get trapped. Three sets of approvals are required to remit funds from China, although the process is simplifying as it will soon no longer be necessary to obtain an advance tax clearance certificate for certain cross-border payments. Ministry of Commerce (MofCom) and State Administration of Foreign Exchange (SAFE) approvals are still needed, alas, but two is better than three.
Addressing tax is another key concern. VAT and duties, business tax and withholding taxes can apply to funds remitted offshore, and the tax charge can become prohibitive if not structured carefully. A final point on taxation. The sting in the dragon’s tail is transfer pricing. China has a much more draconian transfer-pricing regime than the UK and it is essential to provide clear evidence that the transfer pricing rules aren’t being breached.
Whether it is feeding the Chinese Dragon, or putting your hand into the Dragon’s mouth, careful taming of it is needed if you are not to get bitten.
- Understand the local laws and regulations, and follow up on changes.
- Respect local cultures and find trustworthy advisers with good local wisdom.
- Enhance the corporate governance; trust local management, but with appropriate guidance and monitoring from headquarters.
- Emphasise a transparent control environment with smooth information flows.
- Introduce enterprise risk management mechanisms that will build lines of defence into the organisation.
- Plan ahead when moving money into or out of China.
Image: Rama Knight