Wine and Taxes and How to do Business in China.

Evan Osnos’s most recent New Yorker article is so chock full of juicy China law and business (and even tax) tidbits I just know I am going to be rambling a bit in this post. So to make it at least somewhat readable, I am going to take the unprecedented step of breaking this post into sections so I can ramble guilt free, yet with some semblance of cohesion.

Please do not turn away for fear of rambling, for if you stay, I guarantee you will learn plenty. I guarantee it.

I Love Writ Large. I have said it before and I will say it again: the best articles on how to do business in China are those that talk about the trials and tribulations and successes of a particular business. It is easy and not unimportant to say something like how one must conduct due diligence on your China partner, but if that sort of advice is going to stick with you, you need a great storyas to why. At least I do.

I got a complimentary email just yesterday from a reader who touted our “anecdotes” that he “would not be able to get any other way.” I emailed back with the following:

I just wish I could share more anecdotes. As it is, I usually need to wait a long time and then camouflage them so nobody knows about whom I am speaking, especially the clients/near clients.

The funny thing is that we have had only one complaint and that was from some tiny American company in China that told Steve (my co-blogger based in China) it was pissed off at me for having talked about them in a post. The weird thing is that I had NEVER once communicated with this company and Steve had done so only once and he had NEVER told me anything about that conversation (not even that it had taken place) and I never even knew this company existed, much less knew anything about them that would be blog-worthy.

So to this day I have no clue even what they are talking about or even which post we wrote that generated their ire. But that’s what’s so great about the anecdote posts — they absolutely apply to far more people/companies than just the one or two or three companies of which we am writing.

SECTION II. China Taxes and Going Offshore. We seldom discuss taxes on this blog because they tend to be boring and they tend to be so particularized to one’s own particular situation that posts would end up having to be super long to be very helpful. It also bothers me how many small and start-up companies focus too much on taxes and not enough on setting up a strong and legal foundation for generating profits. One of my mentors when I first started practicing law used to tell me that the start-up company that wants to talk more about taxes than anything else never makes it. He would analogize it to the wide receiver in football who starts running away from defenders before he has caught the ball. I too am always surprised/unimpressed by companies that seem more concerned about how to avoid paying taxes on money they have yet to earn and may never earn than on how to set themselves up so that their operations can thrive.

And going “offshore” plays into this. Many years ago, a company came to us with forty or so offshore companies. Yes, forty. I asked them how all these companies were working for them and they said they were a “pain.” I asked why they had set up so many companies and got a somewhat convoluted explanation that I translated to mean that this company’s previous lawyers and accountants had, over time, convinced them of the need for each of them. Note that lawyers and accountants have a bias for advising you form lots of companies. They/we not only make money in the formation, once the companies have been formed, their upkeep becomes a virtual annuity. To make a short story even shorter, we consolidated the forty companies into five and we get “thanks” for this nearly every time we speak with this client for having saved them considerable time, headache, and money.

I am NOT saying there is no place for offshore investments and offshore companies, because there most certainly is. But you should be wary of an adviser who seems overeager to set you up “offshore” or who touts going offshore as a panacea. Always weigh the costs against the benefits.

SECTION III. China Taxes.Yes, Again. But This Time With Even More Feeling.
In the last six months or so, China has become so serious about collecting taxes that I estimate my law firm’s work on such matters has tripled. My firm does nearly all its work on a flat fee basis. And about half the time when we do not flat fee a matter, we do it hourly with a billing cap. We were doing this before the BigLaw crash and we are used to it. Being used to it means we are usually really good at figuring out a fee that is fair for both our clients and for us.

But what we are finding on our more recent China tax/customs matters is that they are taking about twice as much time as we anticipated and that is because they have become not so routine as China is really starting to crack down on foreign company tax reporting. In particular, China is auditing/not trusting valuations and it is holding up all sorts of things to confirm pricing. We are especially seeing this in transfer pricing, where the Chinese tax authorities have been told from above (Beijing) to generate more taxes and they are absolutely seeking to do so by questioning transfer prices between foreign companies and their related Chinese entities. China seems to be issuing a new circular on transfer pricing every other week. We will write more later on how China’s massively increased enforcement of its tax laws is having profound impacts on foreign companies doing business in China, but for now, suffice it to say that it really really is.

SECTION IV. China in the Mainstream Media.
I used to complain fairly often about the quality of reporting on China, but then things started to improve, I started confining my reading to only the better publications, and I also may even have mellowed  a bit. But the overly harsh and uninformed criticisms of President Obama’s trip to China made me realize anew how so many of the people writing for the mainstream media do not know much about that which is outside their own countries.

Three things really bothered me about much of the reporting on Obama’s trip. One, that the stories purported to know what was going on behind closed doors and that Obama had achieved nothing. Two, that they failed to understand that using a bludgeon against China has a long history of ineffectiveness. Three, many of them sought to contrast Obama’s conciliatory approach with the ineffective bludgeoning approach used by GW Bush, but Bush did NOT use a bludgeoning approach with China during his second term.

SECTION V. China Business Today, As It Really Is. Taxes Too.
The November 23 issue of the New Yorker has an absolutely great article by Evan Osnos, in his Letter from China series, entitled, Reds. The article is both fascinating and informative. If I could write like Osnos, I could have and would have written ten such articles, it is that true to life.

The article is about Donald St. Pierre, Sr., who founded A.S.C. Fine Wines in Beijing in 1996, and has taken that company to amazing heights, but who also faced (and mostly beat off) serious customs claims/charges of “falsifying prices” for customs purposes. The article does a great job explaining how A.S.C. so deftly managed to market its wines in China and should be read for that alone. But the parts on how the legal landscape of doing business in China has changed so drastically over the years were what really grabbed me.

The article talks about how it was believed that many (most?) in the wine business were under-reporting the prices they were paying for their product and of how the wine industry, like so many others, had grown too fast for Chinese regulators “to keep pace.” When China really stepped up enforcement against those in the wine business, it secured “punishment” in 29 cases (presumably against 29 different, mostly foreign(?) China wine importers).

Why did so many companies think they could get away with violating China’s laws? Donald St. Pierre has the absolute right answer:

When you first start doing business in China, “No one sits you down and says, ‘You’ve arrived in China. These are the laws.’ Because people just don’t think they apply to them! And they do now.

Donald St. Pierre’s son, Donald Jr., makes a similarly prescient comment:

I think what we went through clearly shows that if you are engaged in business you are subject to the same rules as everybody else.

SECTION VI. It is Very Relevant. Trust Me. The next time somebody insists to me that they do not need to abide by China’s laws (and trust me, there will be such a next time and it will no doubt be fairly soon) because they have such a great reservoir of guanxi or because some local official will be giving them cover or because they are aware of some other company that has gotten away with doing the same thing for years, I am going to tell them to spend $4.99 to download Osnos’s article from the New Yorker. Donald St. Pierre had massive guanxi yet he ended up spending time in a Chinese detention center and his company incurred a six figure fine.

China has laws (plenty of them and they are ever changing as well) and they do apply to foreign companies and individuals (more so than to domestic companies) and a failure to abide by them can lead to trouble. And this has become particularly true in the tax and customs arena.

I guarantee it.

Read More

Legal News