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Global financial management Doing business in China Essay

Global financial management

Doing business in china

Following 20 years of negotiations, China officially joined the WTO on 11 December 2001. China’s accession bears great significance for the country’s economy and the future of global trade. Many industries that were previously restricted only to domestic enterprises are now open to foreign investors. These industries range from banking, telecommunications, distribution, construction, engineering, and insurance to professional services including legal, accounting, and architectural services. Furthermore, restrictions on domestic sales by foreign manufacturing companies will also be lifted. Most of the prior requirements of foreign exchange balancing, local content and export performance will be eradicated in accordance with a WTO timetable. Perhaps the most significant change involves the form of corporate structure. Foreign non-life insurers will be allowed a 51% equity ownership without geographical restrictions two years after WTO accession, and any foreign-invested fund management company or telecommunications company may own up to 49% of the enterprise by 2004 (E&Y Report).

Three primary sectors operate within the Chinese economy: state-owned, collective and private. The state-owned and collective sectors are limited exclusively to domestic businesses. The private sector consists of individually owned Chinese businesses, as well as all foreign business entities.  To promote economic development in certain

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areas, the Chinese government has granted special status to 5 Free Economic Zones, and to 14 open coastal cities, as well as to several coastal open economic zones, high-technology development zones and free trade zones (Country Commercial Guide).

As a socialist country, the government authorities closely monitor China’s economy. The government determines the country’s investment plans according to a five-year plan, with investment and production targets set annually based on the previous year’s performance. The Ministry of Commerce (MOC) or its local delegates must approve foreign-investment projects, depending on their size. Once established, foreign entities must report regularly to the local government agency in charge. Although all matters, including salary and wage rates, and pricing of products, raw materials and utilities supplies are subject to government oversight, centralized control is gradually being relaxed (Ambler, Witzel).

Foreign trade.  Foreign trade is subject to controls to protect the domestic market, limit the use of foreign exchange for imports and ensure that exports will not result in insufficiencies in the domestic market. Foreign trade is regulated primarily through import and export licensing and quotas. The MOC is the authority responsible for setting foreign trade policies and issuing import and export licenses. Foreign investment enterprises (FIEs) that import and export products subject to controls must first obtain a relevant license from the MOC. Commodities subject to license and quota controls are determined by the MOC annually, according to domestic and foreign market conditions, government policies and foreign trade laws.

The government issues notices of goods that are prohibited from being imported into China and goods that are subject to licensing and quota control.  FIEs, when importing capital investments and raw materials for production, must obtain the necessary licenses unless such items are used for export-oriented production. FIEs must submit their import plans every six months to obtain an import license.  Goods that are prohibited from being imported into China are also prohibited from being exported from China. In addition, information that carries state secrets and articles of cultural value are also prohibited from being exported. FIEs must apply for export licenses every six months on the basis of an annual export plan to obtain an export license valid for the current year (Country Commercial Guide).

In China’s liberalized economic regime, there are many ways to finance imports. The most commonplace are the letter of credit and “documents against payment.” Under these methods, foreign exchange is allocated by the central government for an approved import. Other methods are: a) bank or enterprise loans – many Chinese companies have relationships with local banks or other enterprises that will loan funds for the purchase import; b) foreign supplier loan – the supplier helps to finance, on behalf of the Chinese buyer, the purchase of its equipment; proceeds sharing/cooperative joint venture – some suppliers will enter into a cooperative joint venture to ensure the sale and financing of their equipment (Morrison).

Labor.  Under the old so-called “iron rice bowl” system, an individual assigned to a work unit would normally remain with that unit for the rest of his or her working life. Today, some individuals are allowed to seek their own jobs to relieve an overburdened system of its responsibility and to help to find employment for all graduates.  FIEs can integrate a joint venture partner’s work force, hire through a local labor bureau or job fair, advertise in newspapers, or rely on word of mouth. Representative offices, for the most part, must hire their local employees through a labor services agency. Skilled managers, especially those with marketing skills, are often in short supply although many companies have found an abundance of talented and highly-motivated recent university graduates. Experienced managers command salaries far greater than their counterparts in Chinese enterprises, making localization an expensive proposition for many companies. Finding and keeping engineers and technicians can also be difficult.  Many Chinese workers move rapidly from job to job within the foreign-invested and growing private sectors. Workers are paid a salary, hourly wages, or piece-work wages. The provision of subsidized services, such as housing and medical care, is common, and compensation beyond the basic wage constitutes a large portion of a venture’s labor expenses (Country Commercial Guide).

Currency.  China’s official currency is the renminbi (RMB), which is issued by the People’s Bank of China (PBOC). The RMB is denominated in units of fen, jiao and yuan (¥). Ten fen equal 1 jiao, and 10 jiao equal 1 yuan. In general, references to amounts of RMB indicate units of yuan, unless otherwise indicated. In 1994, the government unified the dual exchange rate and the RMB now trades in a managed float. The daily exchange rate is announced by the PBOC based on the interbank rate of the preceding day. Designated banks quote their exchange rates based on the exchange rate and floating range announced by the PBOC.  (Ambler, Witzel). The PBOC and State Administration of Foreign Exchange Control (SAFE) regulate the flow of foreign exchange in and out of the country, and set exchange rates through a “managed float” system. To better control this flow, almost all Chinese enterprises and agencies are required to turn over their foreign currency earnings to the banks in exchange for renminbi.  Foreign-invested enterprises (FIEs) are permitted to keep foreign exchange in foreign exchange accounts at commercial banks. The Chinese government has eliminated the foreign-exchange swap centers on which FIEs used to trade among themselves, and all FIEs have been integrated into the formal banking system (E&Y Report).

Tax Rules.  All FIEs and FEs are subject to the Income Tax Law of the PRC on Enterprises with Foreign Investment and Foreign Enterprises, which is levied by the central government. In addition, local authorities are entitled to levy a surcharge and collect certain registration and license fees. FIEs include Equity joint ventures (EJV), Cooperative joint ventures (CJV) and Wholly foreign-owned enterprises (WFOE). A FIE is subject to tax on its worldwide income. However, a foreign tax credit is allowed for income taxes paid to other countries by branches of the FIE, limited to the PRC income tax payable on the same income. If CJVs are not legal persons, the parties to the joint ventures may elect to be taxed separately on their share of the income received or, with the approval of the local tax bureau, taxed as a single entity. FEs include foreign companies, enterprises and other economic organizations such as representative offices, contracted projects and royalty arrangements. FEs are subject to tax only on their income from PRC sources. The taxation of FEs depends on whether the enterprise has an establishment in China (E&Y Report) .

In general, FIEs and FEs with establishments in China are taxed at an effective rate of 33% (national tax rate of 30% plus local tax rate of 3%). A reduced rate of 15% applies to FIEs and FEs with establishments in China located in Special Economic Zones (SEZs). FIEs engaged in production and manufacturing activities located within the Coastal Open Economic Regions and within the 14 Open Cities, Provincial Capitals and Changjiang Cities, are taxed at a reduced rate of 24%. FIEs engaged in production and manufacturing activities in Beijing and Chongqing are also taxed at a reduced rate of 24%.  FIEs engaged in production and manufacturing activities are granted favorable tax treatment during their start-up period. These entities are granted a two-year tax exemption and a three-year 50% tax rate reduction beginning from the venture’s first profit-making year. In addition to the initial five-year tax holiday, China also grants special tax concessions for certain priority industries, low-profit operations and projects in remote or economically depressed areas.  Foreign investors reinvesting their share of profits in the same investment venture or in a newly created foreign investment venture for a period of five years or longer are entitled to a 40% refund of the tax paid on the amount reinvested. The tax refund increases to 100% if the reinvestment is in an export-oriented or technologically advanced enterprise (E&Y Report) .

Restrictions on Interest Deductions.  Reasonable interest payments on loans are deductible after examination by the local tax bureau. However, no deduction is allowed for shareholders’ loans if the registered capital pledged by the parties is not fully paid-up.  Chinese Government restricts the debt-to-equity ratio of foreign-funded firms and sets minimum equity requirements. For investments under $3 million, debt cannot exceed 30% of the total investment. The debt/capital ratio for investments in the $3-10 million, $10-30 million, and over $30 million ranges cannot exceed 50, 60, and 70 %, respectively. Debt for investments over $60 million is limited to two-thirds of the total value of the investment (E&Y Report).

Long-term investments are stated at the actual cash amount paid or the cost of the tangible/intangible assets contributed, as agreed in the investment contracts. An enterprise must review the value of its long-term investments periodically and value the investments at the lower of cost and the recoverable amount. If the recoverable amount is less than cost, a provision for diminution must be made for the difference. Enterprises must set aside sufficient provisions for bad debts. Losses on bad debts are recognized when a debtor becomes bankrupt or dies and the bankrupt assets or legacy are insufficient for liquidation, or if a debtor has not settled its account for more than three years.

Depreciation and Amortization Allowances.   Based on the nature and utilization method of fixed assets, an enterprise must determine a reasonable expected useful life and expected residual value for each asset, and select a reasonable depreciation method after considering technological development, environmental, and other factors.  An enterprise’s applicable management body, such as a meeting of the shareholders, board of directors or managers must approve the depreciation policy and submit and file the policy with the relevant parties as stipulated by the law or administrative regulations. An approved policy may not be changed arbitrarily thereafter.  Depreciation of tangible properties must be computed using the straight-line method. Unless approval is obtained from the tax authorities, the residual value of fixed assets may not be less than 10% of cost. The tax authorities must approve the use of accelerated depreciation. The following figures show minimum useful lives for certain assets in years: buildings – 20; production equipment, trains and ships – 10; furniture, electronic equipment and other transportation equipment – 5; intangible assets, including technical know-how, patents and trademarks, are amortized over the contractual term or over 10 years if a time period is not specified (E&Y Report).

In conclusion, doing business in China in reality is not that promising and easy. Nevertheless, many companies worldwide have tried to enter the market. They stated being aware of the difficulties and the time needed before achieving profits. China has opened their market more and more but they need to. China needs to open as to satisfy their local needs. Every year, about 12 – 15 million jobs are needed as to keep pace with the population growth (Debate). Besides, the financial market seems to get a little overheated and precaution is required. Companies nowadays face a certain failure in China. Their investments are not paying of and losses are not rare.  Nevertheless, despite all complications, in long term perspective China seems to have a huge investment potential.

References:

Doing Business in China. Tax and Law report. Ernst & Young Global Limited, 2003.

U.S. Department of State FY 2002 Country Commercial Guide: China U.S. & Foreign Commercial Service and the U.S. Department of State, 2002 <http://www.state.gov/www/about_state/business/com_guides/2002/eap/china_ccg2002.pdf>

Ambler, Tim. Witzel, Morgen.  Doing Business in China. 2nd edition. Routledge/Curzon, 2004.

Morrison, Wayne M. China’s Economic Conditions. Congressional Research Service Report IB98014. Foreign Affairs, Defense, and Trade Division. National Council for Science and the Environment. September 21, 2000 <http://www.ncseonline.org/NLE/CRSreports/international/inter-10.cfm?&CFID=14656325&CFTOKEN=96632775>

“Debate: all this talking about China”. Jacqueline Oud – Marketing and Strategy Website. 24th February 2004 <http://www.jacqueline-oud.com/2004/02/24/debate-all-this-talking-about-china-a36.html>

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