Financial Due Diligence in China

Copies of filed accounts can be difficult to extract from the target business. This is largely due to the fact that many businesses in China operate two sets of books - one internal, which shows their true position, and one official, that shows their "official" position. This is, of course very illegal, but is a common practice as tax avoidance in China is rife due to the relatively high level of income tax (25 percent) companies in China have to pay. Well meaning staff, trying to save some money for the company, can inadvertently cause serious compliance and potential liability problems, either through naivety or deliberate actions.

The State Administration of Taxation is also somewhat inefficient at making collections. Some of the SAT's practices - such as making VAT liable on invoicing, not on collection - have also led to inappropriate financial reporting being the norm in many companies based in China. In such cases, sales income may for example be directed to the general manager's personal bank account rather than the company account "to save on VAT" until the full income has been received. Well meaning maybe, but illegal, and certainly a vehicle for potential fraud.

If accounts are run in such a manner, this means that the official set of books as presented to the Chinese authorities and audited will not represent the true strength of the business. The SAT, if finding out such activities, has the right to levy late payment penalties of up to five times the amount due on any taxes paid later than should be properly administered. It can also give staff leverage over an employer if the business is deliberately kept out of compliance. Such activities should be rooted out and accounts and audited accounts reflect the true position, even if the tax burden increases. Operating a business without full disclosure in China is ultimately a false economy and should not be tolerated.

To read the full version of this article, please purchase the March 2010 issue of China Briefing, which can be found in the Asia Briefing Bookstore. Companies requiring assistance may contact any Dezan Shira & Associates' nine national offices at china@dezshira.com for advice or visit www.dezshira.com.