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UPDATED: April 8, 2008 NO.15 APR.10, 2008
Nurturing SMEs (i)
Practical financial, tax and accounting issues affecting international SMEs during the early stages of investment
By CHRIS DEVONSHIRE-ELLIS
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Foreign companies have long looked to China as a means of lowering manufacturing costs and gaining access to a large, developing market. Abundant natural resources, cheaper labor, big local markets and a developed supply chain base combined with local government incentives including tax breaks, special investment treatment and repatriation of profits have been attracting international small manufacturing enterprises (SMEs) to China since the early 1980s. Investing halfway across the globe is not without its challenges though, and there are many problems and difficult issues a China "first-timer" will encounter. For SMEs especially, understanding these problems and issues will be the difference between making and losing money.

Recent economic factors affecting international SMEs

- New policies announced by the Chinese Government

Over the past year, the Chinese Government has announced several new customs policies and taxation policies, including a new corporate income tax law that took effect on January 1, 2008 and a value-added tax (VAT) rebate reduction on some 2,891 types of products in July 2007. Regarding foreign direct investment, the aim of these measures is to encourage high value-added foreign industries into China and move away from pollution-causing, low-tech manufacturing. In the future, the Chinese Government will become increasingly selective of foreign investors. Local governments will welcome hi-tech, high value-added, low-polluting, low natural-resource-consuming foreign investors; and be more restrictive over low value-added, low-tech, labor intensive and resource intensive industries. Furthermore, from 2008, foreign companies no longer receive preferential tax treatment, as they did under the old foreign enterprise income tax law, unless they qualify as a high/new technology enterprise, in which case the company's tax rate will be 15 percent.

- Influence of RMB appreciation

From a global viewpoint, possible influences may be:

1) Asset value increase in China;

2) Advantages for importation;

3) Disadvantages for exportation;

4) Cost increase on renminbi loans;

5) Conversion of earned profits from renminbi into the U.S. dollar;

6) Investment in China will now require more U.S. dollar injection;

7) Labor cost in China may increase.

- Inflation driving costs up

China is beginning to see rampant inflation and the costs of everything from fuel oil and building materials to food are increasing. Raw materials, rent and salaries are just a few of the areas that are affected by China's rising inflation.

- Compulsory deposit reserve ratios increased

The compulsory deposit reserve ratio for banks increased for 10 times in 2007. China also raised interest rates six times last year as the government sought to contain growing inflation. Interest rates may continue to increase further throughout 2008, exerting more influence on banks in China and their capacity to lend money. These moves aim to suck up the excessive liquidity, and squeeze hot money out of the stock and property markets.

Financial, tax and accounting issues

- Different bank accounts with different functions

Why does one need to open so many different bank accounts? Why can we not just use one banking institution to handle all business transactions? Unfortunately, SMEs in China are likely to use at least two to three different banks when it comes to running operations.

SMEs will need to open a capital account to receive foreign investment capital from the holding company, a settlement account in foreign currency if the company has overseas business, and a basic renminbi bank account to pay salaries and other expenses in local currency.

It is also a normal practice to have two additional, separate bank accounts to make payments to the state tax authorities. This bank is selected by the authorities themselves.

Additionally you may need to open a separate loan account to receive loans from the mother company. All these bank accounts have different functions, and the company concerned should clearly define them including arranging for the different signatory authorizations, security levels and related arrangements. From a practical point of view, you may also have to consider choosing a bank logistically closer to your operation base or office reducing the time to withdraw money or issue checks. Finally, as more and more foreign banks are allowed to operate on a much broader scope in China, the foreign investor will be faced with even more options to choose from.

- Initial cash flow problems

International investors are likely to face cash flow problems in the initial investment period: unforeseen expenses in the budgeting phase (we hear this a lot), slow sales revenues, longer credit terms given to clients in order to open up new markets, deposits required at customs and immediate payment requirements by local suppliers before they get to know your company's credit standing. All of these may put an unexpected dent on your wallet at the early stages of your investment.

If you are stretched and need some immediate cash please note that different cities in China may have different local policies on foreign currency control and lending.



 
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