China Whets its Enforcement Appetite and Foreign Companies Are in its Sights

China compliance enforcement

China is watching you. . . .

For the last few months, we have been sounding the theme that China is becoming less beholden to foreign enterprises. We have been saying that the direct corollary of that is China stepping up enforcement of its laws against foreign enterprises. At the beginning of this year, CLB’s own Steve Dickinson recently wrote an article on this for China Economic Review, entitled, China: New Image, New Errors. In particular, our China lawyers have been seeing (and writing about) China stepping up enforcement of its visa, tax, and customs laws.

Not surprisingly, we are not the only people seeing this change. Compliance Week Magazine just came out with an article, China Whets Its Enforcement Appetite, discussing how China has recently become very serious about enforcing its laws as against foreign companies:

For most of the last decade, China seemed to take a light approach on regulatory enforcement; it worried that strict application of its many laws, rules, and regulations would scare off investors when the economy could not afford to lose foreign money and manufacturing.

Now signs are emerging that the days of benign neglect are ending. The government is cracking down on violators of existing regulations, issuing new guidelines and circulars to enhance what’s already on the books, and passing new, tougher legislation.
“Local laws are being stepped up,” says Scott Lane, CEO of the Red Flag Group, a governance, risk, and compliance advisory firm based in Hong Kong. “They are increasing in number and are being enforced.”

The article goes on to note that this new enforcement attitude is here to stay:

China periodically improves enforcement, only to back off when the pain of its efforts becomes apparent; multinational corporations usually just wait out the storm. This time around, all indications are that Beijing isn’t going to retreat in a few months. The latest surge is aggressive and thorough; it also suggests that the new attitude is here to stay.

It then notes a “tremendous” increase in enforcement of China’s tax and customs laws and how penalties for non-compliance are getting quite series as well. Taxation has seen the most obvious changes:

The compliance push began at the start of 2009, when the SAT published guidance that called for individuals and companies operating outside China, but selling services into the country, to start paying China’s business tax. The SAT then followed up with several circulars requiring foreign companies undertaking engineering and service projects in China to register with the agency, even though the companies in question have no permanent presence in China.

Then local tax bureaus sought to charge corporate income and business taxes on parent companies seconding employees to China. Finally, in December, the SAT extended its jurisdiction—in a move called an “amazing leap” by one law firm—to transfer assets overseas. The SAT is showing no inclination to stop at water’s edge.

The article even mentions specific examples of what we see as the biggest bugaboo, transfer pricing issues:

According to one tax accountant, a foreign company in Fujian province was fined $39 million last year in a settlement over transfer-pricing rules. And according to an internal document of the tax authorities in Shandong province, later obtained by KPMG, the Hong Kong subsidiary of a Belgian company was charged $66 million last year in withholding tax. The subsidiary sold shares in Tsing Tao Brewery to another foreign business, and the SAT decided that the transaction between non-residents outside of China was within its jurisdiction. It further concluded that the tax treaty with Hong Kong did not apply and would not protect the two parties.

If you are a foreign company in China, do NOT for a minute think that because your domestic competitors are getting away with not complying with China’s laws you can too:

The government does indeed seem to be giving the local companies a pass. While bureaucrats are raiding foreign-run factories, imposing sizable punishments on multinationals, and making demands on transactions that have little to do with China, enforcement of other domestic regulations come up almost comically short.

If you are a foreign company operating in China, the first and most obvious thing you need to do is to make every effort to follow the laws in the first place, particularly as they apply to company registration, taxation (especially transfer pricing), employment and customs. The second thing you should do is consult with the appropriate governmental authorities when you are unsure. Securing approval from one government official to handle something in a particular way does not guarantee your action will pass muster with some other governmental body, or even some other governmental official within that same body, but it does improve your chances.

Compliance in China. It’s the real thing now.

UPDATE: The Telegraph just did an article, UK businesses threaten to pull out of China over protectionism, talking about many of these same things.

5 responses to “China Whets its Enforcement Appetite and Foreign Companies Are in its Sights”

  1. One other thing a company can do is consider not extending its stay in China or not coming in the first place. As the price of doing business in China goes up it makes sense to re-evaluate global strategy.

  2. Good point, Jay. You have to ask if the risks are worth the learning curve for a singular market that refuses to “go international”. I certainly wouldn’t start an SME in China,I wouldn’t come here with anything less than a corporation that can take some bleeding. The little guy needs a regular playing field if he’s going to have a chance. He/She can’t afford to lose that nest egg when production flounders and budgets triple, after s/he’s in neck deep. That’s hard enough in a liberal democracy with transparent, regular laws, let alone the kingdom of Oz.
    It’s not because Chinese business has a culture of its own. It’s rote incompetence, passivity and narcissism, that elicits sheer rejection of internationalism except through lip service and self service. It’s also “a nickel today is better than a million dollars next year, sucker!”. It’s also “revolving door” customer disservice.
    In the land where money is god, she’s sucked all the joy out of enterprise, the way she’s sucked the joy out of the Olympics, the way she’s sucked the joy out of the internet, and what’s next, life on earth?

  3. Businesses really do have to make these sorts of costs/benefit analysis, but one reason that the Chinese government is able to increase the costs of doing business in China is that over the last few years, the benefits of doing business in China has also increased.
    If you listen to the statements that the government has been making, China really wants to get out of the low cost manufacturing business, and being the low wage factory for cheap products to be exported to US/Europe is something that they are trying to get out of. China is trying to move into increasing domestic consumption and encouraging high wage industries to move into China, and what China really wants at this point is foreign know-how so that it can start it’s own companies.
    One reason that the government is trying to increase tax collection is that there is public demand for more social services, and most social services means more taxes.

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