The China times they are a-changin

Come gather ’round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You’ll be drenched to the bone
If your time to you is worth savin’
Then you better start swimmin’
or you’ll sink like a stone
For the times they are a-changin’

Things are changing for foreign companies doing business in China.

A lot.

Take taxes. Yes, we are always writing about how China has begun cracking down on foreign companies that have China-based employees without a China company (see this Forbes Magazine article, China’s Tax Authorities Want You) and also how China has caught the transfer pricing bug (see this Forbes Magazine article, China’s Tax Authorities Want You, Part 2). But what I am talking about below is different than these two things.

Very different.

Please forgive me for having to be less than direct in this post but those who are familiar with China’s Internet, more particularly, with how it can sometimes be difficult to stay “on the air” on China’s Internet ought to fully understand.

What has been happening of late is really interesting and until I spoke with a leading China reporter who is doing a story on something similar, I did not understand what was happening. I will explain by first telling you what exactly it is that we have been seeing.

Over the last ten years our China lawyers have received probably tens of thousands of calls and emails from foreign companies (mostly North American, European and Australian) companies doing business in China. During these ten years, we have seen many changes in China, some of which come and go and then return again. The closing down of foreign businesses in China for not having a WFOE is one of those (btw, this one is back with a vengeance and we will be writing on that very shortly). But this one is brand new for us I am pretty sure. This one is something we have received five calls on in the last three months or so and I do not recall us ever having received such a call in the previous ten years. Here is the situation prompting the call:

Foreign company operating “legally” in China, or at least legally to the extent that it has a WFOE there, calls us because it is in the midst of a China tax audit. Now to set the stage here, we are a law firm that focuses on helping foreign companies navigate Chinese legal issues; we are not an accounting firm. So when we get China tax calls, they are usually not for help with the basics, but rather when someone realizes that they are in serious legal trouble in China arising usually from a Chinese government accusation regarding a failure to pay taxes. Here is a composite of the recent calls we have been getting:

I am at home in [fill in the blank here with an English language speaking country] and I am not sure whether to go back to China. My company is in the middle of being audited and we are being questioned regarding fake Fapiao. My accountant convinced me that everyone in China uses fake Fapiao and I went along with this. What should I do.

Now a bit more stage setting. In every single instance of the above (but one), the company calling us has never spoken with anyone in our law firm previously, much less retained us as their China attorneys. No, they are calling us totally out of the blue. IN the one case where we spoke previously, I had in my notes that this person “chose not to use us because I made very clear we would not be willing to cut legal corners.” Now to be fair to the recent callers, about half said that they didn’t know that their WFOE had been using fake Fapiaos. And to be fair to the “accountants” mentioned in the call, my pressing in every case revealed that what the callers were talking about was someone more on the level of a bookkeeper in their own company.

Let’s talk for a minute about fake Fapiaos. At their most basic, a Fapiao is an official receipt that allows a Chinese company, such as a WFOE, to take a deduction for an expense. Fake Fapiaos are rampant in China and it is true that a number of companies use them to reduce the amount they need to pay in China taxes. The below comment (left on our blog post, On Being a China Lawyer and on Doing Business in China) describes the prevalence of this practice:

Great interview. You said, “Americans need to start realizing that what American companies got away with five years ago, that era is no more. And the things Chinese companies down the street are getting away with? Well, you’re not a Chinese company.” My consulting company works hard to operate legally in China and we end up paying a lot of taxes. Periodically our our Chinese accounting firm warns us that we will be making a profit and should turn in more FaPiaos (official receipts) or else be taxed. Our General Manager, who is Chinese, tells me that most companies (>80%) try to not show profits in China and practice illegal accounting tactics and bribes to get around paying taxes. It can really bother me at times but it is a reality we must accept. I am comforted at the end of the day knowing that whatever other companies might do, I can sleep with a clear conscience and can stand behind our accounting practices.

Okay, but now, all of a sudden, foreign company after foreign company is being hit with the reality of Chinese tax authorities being unwilling to look the other way. Why is this happening? I think it is because the Chinese tax authorities that might in the past have been happy to look the other way in return for receipt of their own rewards (perhaps from the so-called “accountants” who had allegedly advocated for using fake Fapiaos) have recalculated the risk to reward ratio of doing so and have chosen to fly straight. In other words, what was okay (for a price) in the recent past is no longer okay now.

Like I said, things are really changing in China. But you tell us, are you seeing these things too?

 

 

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Dan Harris

I am a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

I mostly represent companies doing business in emerging market countries. It has taken me many years to build my network and it takes constant communication and travel to maintain it. My work has been as varied as securing the release of two improperly held helicopters in Papua New Guinea, setting up a legal framework to move slag from Canada to Poland’s interior, overseeing hundreds of litigation and arbitration matters in Korea, helping someone avoid terrorism charges in Japan, and seizing fish product in China to collect on a debt.

I was named as one of only three Washington State Amazing Lawyers in International Law, I am AV rated by Martindale-Hubbell Law Directory (its highest rating), I am rated 10.0 by AVVO.com (its highest rating), and I am a SuperLawyer.

I am a frequent writer and public speaker on doing business in Asia and I constantly travel between the United States and Asia. I most commonly speak on China law issues and I am the lead writer of the award winning China Law Blog (www.chinalawblog.com). Forbes Magazine, Fortune Magazine, the Wall Street Journal, Investors Business Daily, Business Week, The National Law Journal, The Washington Post, The ABA Journal, The Economist, Newsweek, NPR, The New York Times and Inside Counsel have all interviewed me regarding various aspects of my international law practice.

I am licensed in Washington, Illinois, and Alaska.

In tandem with the international law team at my firm, I focus on setting up/registering companies overseas (via WFOEs, Rep Offices or Joint Ventures), drafting international contracts (NDAs, OEM Agreements, licensing, distribution, etc.), protecting IP (trademarks, trade secrets, copyrights and patents), and overseeing M&A transactions.