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China Whets Its Enforcement Appetite. And It's YOU It Wants.

By Dan Harris and Steve Dickinson

For the last few months, we have been sounding the theme that China is becoming less beholden to foreign enterprises. We have been saying that the direct corollary of that is China's stepping up enforcement of its laws against foreign enterprises. At the beginning of this year, CLB's own Steve Dickinson wrote an article on this for China Economic Review, entitled, "New Image, New Errors" and earlier this week, we ran a revised version of that article in a post, entitled, "With China's New Standing Come New Errors." In particular, we have been seeing (and writing about) China stepping up enforcement of its visa, tax, and customs laws. Not surprisingly, we are not the only people seeing this change. Compliance Week Magazine (h/t to China Tax Insight) just came out with an article entitled, "China Whets Its Enforcement Appetite," in which it discusses how China has recently become very serious about enforcing its laws as against foreign companies:

For most of the last decade, China seemed to take a light approach on regulatory enforcement; it worried that strict application of its many laws, rules, and regulations would scare off investors when the economy could not afford to lose foreign money and manufacturing. Now signs are emerging that the days of benign neglect are ending. The government is cracking down on violators of existing regulations, issuing new guidelines and circulars to enhance what?s already on the books, and passing new, tougher legislation. ?Local laws are being stepped up,? says Scott Lane, CEO of the Red Flag Group, a governance, risk, and compliance advisory firm based in Hong Kong. ?They are increasing in number and are being enforced.?

The article goes on to note that this new enforcement attitude is here to stay:

China periodically improves enforcement, only to back off when the pain of its efforts becomes apparent; multinational corporations usually just wait out the storm. This time around, all indications are that Beijing isn?t going to retreat in a few months. The latest surge is aggressive and thorough; it also suggests that the new attitude is here to stay.

It goes on to note a "tremendous" increase in enforcement of its tax and customs laws and how penalties for non-compliance are getting quite series as well. Taxation has seen the most obvious changes:

The compliance push began at the start of 2009, when the SAT published guidance that called for individuals and companies operating outside China, but selling services into the country, to start paying China?s business tax. The SAT then followed up with several circulars requiring foreign companies undertaking engineering and service projects in China to register with the agency, even though the companies in question have no permanent presence in China. Then local tax bureaus sought to charge corporate income and business taxes on parent companies seconding employees to China. Finally, in December, the SAT extended its jurisdiction?in a move called an ?amazing leap? by one law firm?to transfer assets overseas. The SAT is showing no inclination to stop at water?s edge.

The article even mentions specific examples of what we see as the biggest bugaboo, transfer pricing issues:

According to one tax accountant, a foreign company in Fujian province was fined $39 million last year in a settlement over transfer-pricing rules. And according to an internal document of the tax authorities in Shandong province, later obtained by KPMG, the Hong Kong subsidiary of a Belgian company was charged $66 million last year in withholding tax. The subsidiary sold shares in Tsing Tao Brewery to another foreign business, and the SAT decided that the transaction between non-residents outside of China was within its jurisdiction. It further concluded that the tax treaty with Hong Kong did not apply and would not protect the two parties.

And if you are a foreign company in China, do NOT for a minute think that because your domestic competitors are getting away with not complying you can too:

The government does indeed seem to be giving the local companies a pass. While bureaucrats are raiding foreign-run factories, imposing sizable punishments on multinationals, and making demands on transactions that have little to do with China, enforcement of other domestic regulations come up almost comically short.

So what do you do if you are a foreign company operating in China? The first and most obvious thing is to make every effort to follow the laws in the first place, particularly as they apply to company registration, taxation (especially transfer pricing), labor and customs. The second thing to do in many of these instances is to consult with the appropriate governmental authorities when you are unsure. Securing approval from one government official to handle something in a particular way does not guarantee your action will pass muster with some other governmental body, or even some other governmental official within that same body, but it does improve your chances. Compliance in China. It's the real thing now.

Full post as published by China Law Blog on January 16, 2010 (boomark / email).