Are you seeking to expand operations to China? It is vital to have a sound knowledge of the various compliance requirements. You will be confronted with a host of them that demand strict adherence. Non-compliance can have dire consequences, leading to hefty fines. You may also risk being blacklisted and prohibited from repatriating profits. Serious violations could even result in the revocation of your business licence, severely hampering your prospects of doing business in China in the future.
China’s ever-changing regulatory landscape requires you to stay on top of your company’s compliance at all times. To complicate matters even more, requirements and procedures can vary from locality to locality. Each region may impose further conditions, such as requiring additional content to be inserted into audit reports. Regional specificities no doubt add to the burden of compliance. Enlisting the services of a professional advisor would greatly ease the burden and reduce the risk of non-compliance.
With important deadlines one after another, meeting your annual compliance obligations can indeed be a complex and confusing affair. In this article, we will delve into the main annual compliance requirements that every company operating in China should be aware of. Such obligations involve conducting different statutory filing and financial reporting procedures. The article will also provide you with other useful insights to help you navigate the labyrinth of compliance policies.
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Why is it important to meet your annual compliance obligations?
Besides the unpleasant prospect of substantial penalties and fines, there is a very compelling reason why you are well advised to fulfil your annual compliance obligations. In order to repatriate profits from China, you must complete the annual audit and corporate income tax (“CIT”) filing beforehand. Failure to do so would result in hold-ups in repatriating profits to your home country and distributing dividends to shareholders. Based on the audit report, the tax authorities will inspect whether your company has been acting in compliance. In addition, they 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, you are required to fulfil certain conditions and submit the necessary documentation. Generally speaking, the whole process can take up to a month, depending on the complexity of the case.
Documents that need to be submitted usually include the following:
- Business licence
- Tax filing certificate
- Document showing total tax liability
- Board resolution on allocation of profits
- Audit report on financial statements by a Certified Public Accountant (“CPA”)
- Audit report on the recorded capital contributions paid in by shareholders
As a foreign-invested enterprise (“FIE”), you are required by law to conduct an annual audit. Pursuant to Article 164 of China’s Company Law:
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. Financial and accounting reports of companies shall be prepared according to laws, administrative regulations and regulations of the finance department of the State Council.
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.
Such financial statements typically include:
- Cash-flow statements
- Profit and loss statements
- Balance sheet
- Statement of changes in equity
- Supplementary notes on financial indicators
China’s Company Law stipulates that a mainland Chinese-registered CPA must conduct a company’s statutory audit report. It is at your discretion whether you choose to consult a foreign-registered professional on the procedural aspects of compliance. However, the audit process itself must be conducted by a local CPA. The final audit report must also be prepared by a licensed CPA in mainland China.
How to prepare for the annual audit
The tax year in China follows the calendar year, beginning on 1 January and ending on 31 December. Companies complete their annual compliance procedures after the end of the tax year, which last until the end of June. In order to meet the annual CIT filing deadline in May, it is highly advisable to finalise the annual audit by the end of April.
- Conduct a comprehensive stock-take of all assets
If it has been a long time since you carried out a full inventory of your company’s assets, you are well advised to take one to check the existence, condition, and value of assets. This is to facilitate the auditor’s verification of your company’s assets during the audit process. In addition, you should perform the inventory check near the end of the tax year to ensure it is as up to date as possible when you undergo the audit.
You may also have to make arrangements for impairment assessments with your auditor. Impairment refers to a reduction in the value of an asset due to obsolescence, damage, theft, changes in market conditions, and other factors. The auditor will assess for any impairment loss and ensure that it is accurately reflected in your financial statements.
- Have your VAT invoices in order ahead of time
Sales and purchases are commonly regarded as the areas that are most susceptible to irregularities in an annual audit. Hence, particular attention is devoted to scrutinising 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 very important to obtain the relevant invoices – if any are missing – 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, you should prepare the annual CIT reconciliation accordingly. While the deadline is 31 May of every year, the tax compliance investigation itself can be a protracted process. If complexity is involved, it may last well 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, a standard CIT rate of 25 per cent is applicable. The standard rate usually applies to resident enterprises as well as non-resident enterprises. Such enterprises have a formal establishment in mainland China and derive income from sources inside as well as outside mainland China that are connected with such establishment. You may, however, be able to benefit from special rates if you operate in certain industries. A concessionary tax rate of 15 per cent also applies to enterprises incorporated in specific regions in mainland 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.
In light of inconsistencies between Chinese tax law and the prescribed accounting standard, you should address any deviations by making the necessary adjustments in the annual CIT reconciliation. This is important since the inconsistencies create a discrepancy between the taxable income and that indicated in the accounting records. The annual CIT reconciliation, therefore, resolves these differences. Further, it ensures that all tax liabilities have been settled and determines if any additional tax is payable, or if a reimbursement is necessary.
- Related-party transactions
It is common practice for FIEs in China to conduct transactions with affiliated parties, such as with 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. In particular, 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. As such, 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.
Pursuant to Article 43 of China’s Corporate Income Tax Law, FIEs that regularly engage in related-party transactions are required to submit an Annual Related-Party Transaction Report (“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. But you need not disclose the specificities of the pricing strategy adopted.
This notwithstanding, you should bear in mind that you will need to submit additional documentation if you engage 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 30 June. The aim of the annual report is to ensure that all information related to the FIE is up to date across all government departments.
Prior to the promulgation of the new Foreign Investment Law in 2020, FIEs had to file an annual report with the local Administration for Market Regulation and other government authorities, including the Ministry of Commerce and the State Administration of Foreign Exchange. The new Foreign Investment Law has streamlined and simplified the submission process. You can now complete the entire filing process online via the National Enterprise Credit Information Publicity System.
Information to form part of the annual report includes the following:
- General information about the FIE, including its name, address, business scope, registration status, number of employees, etc.
- Financial information, including total assets, total liabilities, total owners’ equity, gross and net profit, etc.
- The FIE’s creditworthiness and debt obligations
- Tax incentives enjoyed by the FIE
- Licences held by the FIE
- Intellectual property owned by the FIE
- Customs-related information if the FIE falls under the purview of the customs office
- Shareholder contributions and any equity transfers
- The FIE’s ultimate beneficial owner(s)
The importance of complying with annual reporting requirements should not be under-estimated. Non-compliance can have detrimental consequences on your current as well as future investment activities in China. If you miss the filing deadline or include bogus information, you run the risk of being put on the List of Enterprises with Abnormal Business Operations. Further, if this occurs for three consecutive years, your company may be blacklisted.
What can CW do for you?
At CW, we recognise the importance of maximising your time and resources to drive value for your business. We understand that staying on top of the ever-evolving and increasingly complex regulatory landscape only adds to your compliance burden.
Well-versed in the intricacies of local regulations, we provide comprehensive and holistic support in helping you manage all your corporate compliance obligations. Our firm has a dedicated team comprised of seasoned professionals, who can assist in handling the various filing complexities to ensure seamless continuity in your business operations.
Get in touch to find out how we can support your business growth and achieve all-round compliance for your FIE.