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Non-compliance can have dire consequences in China

Foreign companies operating in China must navigate effectively a complex legal and compliance environment. Most businesses are confronted with a host of requirements that demand strict adherence. Non-compliance can have dire consequences in China, leading to hefty fines, loss of licenses, and prohibition to repatriate profits, among other.  


Non-compliance could severely affect any prospects of doing business in China. It is crucial to ensure compliance to avoid legal issues.  


China’s ever-changing regulatory landscape requires foreign companies to always maintain compliance. To make things even more complicated, requirements and procedures can vary from locality to locality.

Each region may impose further conditions, such as additional content to be inserted into audit reports. 

With multiple important deadlines, annual compliance obligations can become complex and confusing.

Some of these obligations involve conducting different statutory filing and financial reporting procedures.  


Some businesses that are perfectly legal in the United States or Europe are illegal in China. Operating legally in China requires the formation of an entity, such as a WFOE (wholly-foreign-owned enterprise), a Joint Venture (JV), or a representative office.  


Profit Repatriation 


Besides the unpleasant prospect of penalties and fines, fulfilling annual compliance obligations allows a company to repatriate profits. To do so, a business must complete the annual audit and corporate income tax (CIT) filing beforehand.  


Failure to do so would result in hold-ups in repatriating profits and distributing dividends to shareholders. Based on the audit report, the tax authorities will inspect whether the company has been acting in compliance.  


Additionally, authorities will investigate whether CIT has been duly settled on the profits earned. By referring to the net profit figure provided, they will then calculate and determine the amount allowed to be repatriated. 


To initiate the process of repatriating profits, it is required to fulfil certain conditions and submit the necessary documentation, such as audit reports, tax documents and business license. The whole process can take up to a month, depending on the complexity of the case. 


Annual audit 


Foreign-invested enterprises (FIEs) must conduct an annual audit. China’s Company Law states that companies shall prepare financial and accounting reports at the end of each fiscal year. Such reports shall be audited by an accounting firm according to the law.

  

Conducted by an external independent auditor, an audit is a comprehensive and unbiased examination of a company’s financial statements as well as accompanying records and processes. The objective of an audit is to verify that such items provide a reliable and accurate depiction of a company’s financial health at a specific point in time. 


China’s Company Law stipulates that a registered CPA must conduct a company’s statutory audit report. Foreign companies can consult a foreign-registered professional, however, the audit process itself must be conducted by a local accountant. 


The tax year in China follows the calendar year, beginning on January 1, and ending on December 31. Companies complete their annual compliance procedures after the end of the tax year, which lasts until the end of June.  


Companies should execute a full inventory of assets, including existence, condition, and value of assets, to facilitate the auditor’s assets verification during the audit process. This should be done by the end of the tax year to ensure it is as up to date as possible. 


Value Added Tax (VAT) 


In an annual audit, sales and purchases are regarded as the most questionable areas. Authorities tend to scrutinize the accounting records to ensure their authenticity and accuracy. This usually involves cross-referencing transactions against inventory levels, relevant orders, invoices, and contracts. 


VAT invoices or fapiaos issued by the tax bureau serve as legal proof of purchase of goods and services. They contain information about the seller, the buyer, invoiced amount, taxable amount, and the taxpayer identification number.  


Aside from serving as proof of purchase, fapiaos also operate as expense vouchers used for tax deduction purposes. It is important to obtain the relevant invoices well ahead of the audit. Without the accompanying invoices, such expenses will not qualify for tax deductions.

 

Annual corporate income tax filing 


Following the completion of the annual audit, companies must prepare the annual CIT reconciliation accordingly. While the deadline is May 31, the tax compliance investigation itself can be a protracted process. If complexity is involved, it may last into the latter half of the year – sometimes until the end of the year. Thus, it is essential to have all supplementary documents on hand and provide them upon request by the tax authorities. 


In China, the standard CIT rate is 25% and it usually applies to resident and non-resident enterprises operating in the country. Certain industries benefit from special tax rates. A concessionary tax rate of 15% also applies to enterprises incorporated in specific regions of China. 


Companies are required to pay CIT either monthly or quarterly. In addition, they must file their tax returns within 15 days following the end of each month or quarter. The annual CIT reconciliation resolves any discrepancies and ensures that all tax liabilities have been settled, determining if any additional tax is payable, or if a reimbursement is necessary. 



Related party transactions 


FIEs in China generally conduct transactions with affiliated parties, such as their parent company. For example, through the provision of services to the FIE, the parent company could repatriate funds from the FIE in the form of service fees. This is, however, governed by certain conditions and regulations. 


Intercompany transactions are subject to the arm’s length principle and should, therefore, be on the same terms and conditions which would have been agreed between independent entities under similar circumstances. 


Related-party transactions can trigger concerns regarding transfer pricing, which could potentially be a vulnerable area in a company’s tax compliance. Transfer pricing refers to the means used to determine the price of goods and services traded between associated companies based in different tax jurisdictions. It is important to ensure that such transactions are conducted in accordance with the arm’s length principle and comply with the relevant tax laws. 


China’s Corporate Income Tax Law states that FIEs that regularly engage in related-party transactions are required to submit an Annual Related-Party Transaction Report along with their annual CIT return.  


The Report contains details of the transactions conducted with affiliated entities, including the pricing of transactions as well as information on the related parties and their connection to the FIE.  


Additional documentation may have to be submitted if a company engages in any related-party transaction (regardless of value and amount) when the transaction takes place. This may include any contracts signed between the affiliated parties, purchase agreements, employment contracts, and other relevant documents. 


Combined annual reporting 


To be done in conjunction with the above two steps, combined annual reporting must be completed by June 30. The aim of the annual report is to ensure that all information related to the FIE is up to date across all government departments. 


Since the new Foreign Investment Law was approved, companies can complete the entire filing process online via the National Enterprise Credit Information Publicity System. 


Additional areas 


There are additional areas where compliance is necessary, such as intellectual property (IP) registrations. To secure protection of trademarks and patents in China, they must be first registered. These registrations must be renewed regularly, and trademark use must follow the legal requirements of the Trademark Law. 


Data Privacy Laws 


In recent years, the Chinese government has enacted several laws and regulations aimed at protecting personal data, including the Personal Information Protection Law (PIPL), which came into effect in November 2021.  


The PIPL imposes obligations on companies that collect and process personal data, requiring them to obtain consent from individuals, implement data security measures, and conduct data transfers in accordance with the law. 


For foreign companies operating in China, compliance with the PIPL is crucial to avoid legal ramifications and reputational damage.  


Failure to comply with the PIPL can result in significant fines, penalties, and even criminal charges. To ensure compliance, companies should consult with legal professionals and implement appropriate data governance policies and procedures. 



The importance of complying with legal requirements in China should not be underestimated. Non-compliance can have detrimental consequences on future investment activities in China. 




 

Woodburn Accountants & Advisors is one of China’s most trusted business setup advisory firms.


Woodburn Accountants & Advisors is specialized in inbound investment to China and Hong Kong. We focus on eliminating the complexities of corporate services and compliance administration. We help clients with services ranging from trademark registration and company incorporation to the full outsourcing solution for accounting, tax, and human resource services. Our advisory services can be tailor-made based on the companies’ objectives, goals and needs which vary depending on the stage they are at on their journey.

 

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