Business Structure, Due Diligence and Repatriation of Profits from China
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1 Business Structure, Due Diligence and Repatriation of Profits from China Grant Thornton China Wilfred Chiu Tax Partner Carol Cheng Transaction Advisory Service Director June 2012.
2 Invest in China Introduction Business structure and compliance overview Cash repatriation Important considerations Common due diligence issues in China 2
3 Map of China 3
4 Do you recognize where? 4
5 Do you recognize where? 5
6 FDI in China As at the end of 2011, FDI in China had reached 1.16 tr. Taking the lead among developing countries for 19 years FDI (US$ billion)
7 M&A Market in China China has become the preferred target market of M&A activities. The report indicates that 86%of interviewees are focusing on China market. [Asian Financial Officer Market Outlook Report (Feb) 2012] China accounted for 33% of M&A activities in Asia, after the US to become the world's second largest M&A market, with transaction amount accounted for 7.5% of global total. [2011 China M&A Market Report -Thomson Reuters] 7
8 Invest in China Business Structure and Compliance Overview 8
9 Invest in China - Types of Set-up Representative Office (RO) Wholly-Owned Foreign Enterprise (WOFE) Equity Joint Venture (EJV) Cooperative Joint Venture (CJV) Foreign Invested Commercial Enterprise (FICE) Investment Company (CHC) Regional HQ Partnership Branch 9
10 Invest in China - RO vs FIE RO FIE - WOFE FIE - EJV Not a legal entity No direct business, only liaison etc activities Legal entity with limited liabilities Can receive income from customers & issue fapiao Legal entity with limited liabilities Can receive income from customers & issue fapiao No capital commitment Capital commitment 100% foreign s/h Articles of Association Capital commitment Min 25% foreign s/h Risk, profit and loss share per % of s/h AoA and JV contract 10
11 Invest in China - Procedures of Setting Up a FIE 1. Name registration 2. Application with Ministry of Commerce Temporary Business License (legally registered) 3. Commencement registrations (8 authorities) Open capital bank account Capital injection and capital verification audit Renewal Business License with the amount of paid-up capital 11
12 Invest in China - Compliance Overview Books and records Chinese (& English) Keep for at least 10 years Calendar Year End Chinese GAAPs Statutory Audit & Forex Audit Official Tax Receipts (FaPiao) Forex Control 12
13 Invest in China - Major Taxes Turnover Tax VAT/BT Corporate Income Tax Individual Income Tax and Social Insurance (Withholding obligations) 13
14 VAT Import or sales of movable goods, processing and repairing services Std rate17% (13% for specified goods, 0% for export) Input VAT credit available for general taxpayer Small-scale taxpayer 3% w/o credit Mainly on monthly basis 14
15 BT Services, transfer of intangible assets, sales of immovable properties Services - service provider / recipient in China Tax rate 3%-20%, mostly at 3% and 5% No input tax credit Mainly on monthly basis VAT on transportation and modern services in pilot programme (17%,11%, 6%) 15
16 Corporate Income Tax Tax resident - worldwide income at 25% 5-year tax loss c/f Provisional quarterly Annual settlement by May 31 WHT in general 10% Extensive tax treaty network 16
17 Individual Income Tax IIT on employment income at 3-45% progressively Withholding obligations on a monthly basis 17
18 Invest in China Cash Repatriation 18
19 Invest in China Cash Repatriation CA Co BT WHT Dividend N/A 10%* Interest 5% 10%* PRC Co Royalty 5% 10%* Service Fee # 5% DTA * If meet the beneficial owner and other requirements Management fee not deductible # Transfer Pricing / Deemed Profit Rates 15%-50% for NTR 19
20 Invest in China - Cash Repatriation Dividend Flowchart WHT filing & clearance Other Payment Flowchart Contract registration WHT filing & clearance SAFE Approval Bank Payment Bank Payment 20
21 Invest in China Important Considerations 21
22 Intermediate Holding Company - Inbound into China CA Co Hold Co For lower WHT and/or finance funding and/or exit, e.g., may use HK, (or Lux/HK) PRC -> HK 5%* (0%) HK -> CA 0% (0% or 5%) Challenges Beneficial Owner? Commercial Substance? PRC Co 22
23 Beneficial Ownership circular [2009]601 "Beneficial Owner" to qualify for tax treaty treatment: - Whether the applicant has ownership or control over the income or the rights or assets that generated such income. Whether the applicant engages in substantive business activities. An agent or a conduit company, incorporated for the purpose of avoiding or reducing taxation, transferring or accumulating profit without any substantial business activities, is not a beneficial owner. 23
24 Indirect Equity Transfer by non- Residents Guoshuihan [2009] No. 698 Indirectly transfers of the equity of Chinese resident enterprise Offshore holding company location levies no taxation on the foreign income of its residents or levies taxation on the foreign income of its residents of a percentage lower than 12.5% Obligation for the seller to submit documents Economic substance or denial of the existence of the offshore holding companies used for tax avoidance arrangement Adjustments of the transfer price based on arm s length principle 24
25 Circular 698 implications Chongqing case, Jiandu case, Shanxi case Look through Potential reporting obligations Withholding tax 25
26 Market Entry Consideration Catalogue for the Guidance of Foreign Investment Industries (2011) 354 Encouraged, 80 Restricted, 39 Prohibited industries. China Government's 12 th Five-Year Plan 26
27 China Government's 12 th Five-Year Plan To nurture 7 new strategic industries: - New generation information technology Energy saving and environment protection New energy Biotechnology and biochemistry High-end equipment manufacturing New materials New energy cars 27
28 China Government's 12 th Five-Year Plan Accelerate the growth of the following service sectors: - Elderly care Logistics Education Healthcare Sports Financial sector 28
29 Tax Incentives Incentives available to specified sectors / locations:- Agriculture, forestry, husbandry, fishery CIT exemption / reduction Infrastructure projects CIT holiday (3+3) Environmental & water conservation projects CIT holiday (3+3) High-New Tech companies 15% (and others) ITO / BPO / KPO BT exemption Software & IC manufacturers - "2+3" or "5+5" or 10% CIT rate Technology transfer - first RMB5m exempt and 50% reduction thereafter Incentives for Going West - 15% CIT rate SEZs & Pudong New Zone HNT companies CIT holiday (2+3) 29
30 High-New Technology Enterprises 15% tax rate 150% deduction on R&D expenditure 150% amortisation capitalised intangible assets Qualifying conditions: Own IP in China More than 30% of workforce with diplomas More than 10% of workforce in R&D R&D expenditure = 3% - 6% of total revenue 60% of R&D activities in China 60% revenue from high-new tech products Certificate valid for 3 years and needs re-applying 30
31 Other Considerations No virtual office / paper company Minimum registered capital local requirement/practice Total Investment vs Registered Capital Forex control Time-frame Transfer pricing BT / VAT reform Local practice 31
32 Invest in China Common Due Diligence Issues in China 32
33 Common Due Diligence issues Multiple sets of books Poor quality / unreliable financial information Financial control weakness Non-compliance with labor laws Related-party transactions Transfer pricing Contingencies Grant Thornton China All rights reserved. 33
34 Multiple sets of books Some Chinese private companies may have multiple sets of books What are they? And Why? Not just "accounting" vs "tax" accounts, management accounts vs statutory accounts Cash books, tax books, audit accounts etc Significant tax exposure Revenue was understated Large unrecorded tax liability or exposure Grant Thornton China All rights reserved. 34
35 Poor quality / unreliable financial information It is common that some private companies do not have complete financial information, such as: non-compliance with China GAAP, cash basis rather than accrual basis poor financial reporting controls in place lack of computerized accounting system, only use manual Excel spreadsheets tax noncompliance issue no regular statements of cash flows is compiled no regular consolidated financial statements inexperienced accountant Grant Thornton China All rights reserved. 35
36 Financial control weakness Poor quality of accounts may result from weakness of financial control, such as : improper treasury controls (Fraud risk) improper company seals keeping policies and procedures management accounts are not prepared and analyzed on regular basis lack of KPIs and performance assessment heavily reliance on key personnel, rather than system and controls Grant Thornton China All rights reserved. 36
37 Non-compliance with labor laws No proper employment contracts in place Underpayment of individual income tax Underpayment of social welfare and insurance for staff cost saving purpose, including pension, medical insurance, housing fund etc Fines and labour disputes May result in a potential large unrecorded liabilities for a buyer Grant Thornton China All rights reserved. 37
38 Related-party transactions Relatives of the owners or managers may be on the company s payroll Customers may include related or affiliated companies Key suppliers may be related or affiliated by common ownership Other factors relates to related-party transactions include: Informal arrangements, often oral agreements Lack of internal borrowing contracts and documents Nature of related-party transactions is unclear Uncertain related-party receivable / payable balances Grant Thornton China All rights reserved. 38
39 Transfer pricing The seller may have sales or purchases to related or affiliated companies are involved. The ownership of Chinese companies is not always transparent and may be quite complex. Transfer pricing policies need to be understood and documented so they can support a tax position. Grant Thornton China All rights reserved. 39
40 Contingencies Contingencies arise from off-balance sheet obligations and unrecorded liabilities and can be significant surprise to a buyer. Contingencies can refer to a number of different off-balance sheet liabilities, such as: taxes, leases, litigation, guarantees and environmental compliance issue Thorough due diligence is required to identify and quantify these risks. How the transaction is structured is also critical to who owns these liabilities post-close. Grant Thornton China All rights reserved. 40
41 Questions Any questions? Grant Thornton China All rights reserved. 41
42 Key Contacts Wilfred Chiu Tax Partner T E wilfred.chiu@cn.gt.com Carol Cheng TAS Director T E carol.cheng@cn.gt.com 42
43 Grant Thornton China 谢谢! Thank you!. 43
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