Doing Business in China - Common War Stories

By Ron Cohen, CPA, MST
Partner
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.

Common anecdotes:

1. 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).



2. 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 minister.



3. 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.



4. 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.



5. 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.
   


6. 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.