Doing Business in China - Common War Stories
By Ron Cohen, CPA, MST
Greenstein, Rogoff, Olsen & Co., LLP
As time passes, I hear from
reliable sources the same type of stories, over and over, about doing business
in China. So, I thought I’d pass along some recent reviews:
Assume a taxpayer sets up a
Wholly-Owned Foreign Enterprise (W.O.F.E.) and manufactures products (directly
or via a contract manufacturer) in China to take advantage of their low labor
costs, local manufacturing expertise and logistical location near customers.
- 40%, I’m told, of your inventory
will disappear out the back door of the factory to employees, friends, family
and worse, competitors (who will reverse-engineer your product to find and
duplicate your core technology).
- Your legal, negotiated tax deal
(tax rate holidays or rate reductions) signed, sealed and duly recorded with one
provincial minister is abruptly over-turned and subject to renegotiation (with
the related required “under-the-table” payments) when the new minister takes
over. Small wonder why, often, the richest guy in town is the government
- Say you’re an electronic parts
supplier. Your customer’s purchasing manager (assuming you sell your parts to a
manufacturer in China that makes a larger product) mishandles your product
(stores it too hot or too cold or has it incorrectly installed), and has the
Purchase Order for your product cancelled, since it is clearly “defective.”
Then, the purchasing manager has a new Purchase Order approved for a factory
owned by a family relative located in the next hamlet, who copies your design.
- My Favorite: Large businesses
start a tax audit with a “conference meeting” with a team from the tax
authority. This is common throughout the world. This allows the parties to
review the process for conducting the tax audit and to introduce tax
issues and areas the tax authority expects to review, so everyone can prepare
and move forward in a timely manner.
Recently, a very
large, U.S. public company had their W.O.F.E. audited. In the opening
conference, the Chinese tax inspector’s opening comments were, paraphrasing:
Times are bad in China. We need money. Don’t tell me about the tax
law or the tax treaties. How much can you pay?
The company believes
they timely filed a legitimate, honest tax return in China. However, based on
the inspector’s comments, that was not relevant. One must wonder whether their
tax system is de-evolving from a vailed-attempt at the Rule Of Law to,
unfortunately, a system of blatant pay-offs. A U.S. company (or subsidiary
thereof) must always be mindful of the U.S. Foreign Corrupt Practices Act, under
which foreign bribes and pay-offs result in potential U.S. crimes. Clearly, this
is an on-going dilemma.
- We’ve heard that a leading Chinese Language Internet Search Provider charges advertising fees as follows:
A company that wants to advertise is charged based on their size and what the Internet company determines they should pay…without regard to
the potential “hits” or “eyeballs” their ad will receive. If the advertiser objects and declines to advertise, they shortly thereafter find that information about
their company is dropped and no longer comes up as “search results.” That is, it is like as if you decided not to advertise on Google, and the next day, no one could
find information on your company by searching on Google… in retaliation for not paying advertising fees. Of course, Google does NOT do that.
- Here’s a Wall Street Journal Editorial that outlines the controlled and centralized nature of China’s economy and the growing disparity
between rich and poor (the U.S. has also suffered from a growing disparity between rich and poor since the 1960’s, so, unfortunately, the U.S.
is no shining example on that issue.)
See: Rich China, Poor Peasants
Doing business in China
seems to have a much higher-than-normal level of risk compared to other
countries we deal with. So please be careful.
Economically, most companies
have no choice but to do some manufacturing or other business in China. So,
often, these risks are just “factored-in” as a cost of doing business. Small
companies must be very careful as they can’t absorb the type of losses listed
above the way, perhaps, a larger company can.
I am always available for
questions or comments at (510) 797-8661 x237.