Preparing For Your China Annual Audit Inspection: Financial Compliance

When preparing for China’s annual audit, there are a number of initial issues that can be prepared at little or no trouble to prepare for this. In the first of this two-part article, we discussed legal compliance. Here, we discuss financial overviews that can ensure your business is as profitable and healthy as possible.

Chinese Internal Accounting Systems 

It is wise to have a third party conduct a review of your books at this time of year. China’s fiscal year runs from January 1 – December 31, with 2015 audits needing to be filed within the first few months of next year. Presenting auditors with flaws in the accounts can be an expensive business to correct, and it is far better to conduct a financial review in advance.

Common areas looked at include the relationship between sales and inventory, checking of sales and purchase prices in the market (having a purchasing manager insert themselves into a company and inflate purchases from a supplier they are related to is very common). Other checks include related expenses, even for items such as canteens. One internal check we recently conducted in South China showed purchases of foods at a ratio 10 percent higher than the numbers of actual staff. This excess food was being sold out of the back door. Internal checks are a useful tool to get your accounts in order and to discourage financial abuse.   

RELATED: Audit & Financial Review Services from Dezan Shira & Associates

Human Resources

HR is a complicated financial subject in China, especially for companies operating in multiple locations. Ensuring the head count is accurate (Uncovering false personnel with someone claiming their wages is not uncommon), as well as ensuring all mandatory welfare payments –  which differ on a city to city basis across China – are correct and up to date is an important box to check. 

Related Party Transactions

Transfer pricing, which relates to the permissible product discount relationship between related companies (such as a parent and its China subsidiary), is a hot topic in China, and the tax authorities look at this with detail. Getting your TP policy in line with China’s regulations on the subject is important, as if too much taxable income has been give away in the form or relationship discounts, the tax authorities can deem this to be tax evasion. That is a serious offense and can result in significant fines. It is best to run the rule over your related party transactions policy to ensure that it stands up to Chinese scrutiny.   

RELATED: China Releases New Draft of Transfer Pricing Documentation Rules

Enabling Double Tax Treaty Benefits

If your China business has a parent domiciled in a country that has a Double Tax Treaty with China, then there are tax reduction benefits that can be applied to increase the overall Group profitability from the related Parent-China Tax Structure. Items such as IP, IT and other corporate support, as well as permissible other support functions, can be levied upon the China operations by the parent. The Withholding Tax typically due on these transactions is lower than China’s CIT and dividends tax rate (35 percent) and can be additionally subject to a further 50 percent discount if the relevant DTA status is invoked. This can effectively reduce your China profits repatriation tax costs from 35 percent to 10 percent.

A list of all countries China has DTA with can be found here. Taking advice on how to implement these benefits is not only a good reason to review your corporate financial structures; it can enhance your overall profitability as well.

Dezan Shira & Associates has over 23 years of operational experience in China and can assist with internal checks and balances. Please contact the firm at china@dezshira.com or visit the practice website at www.dezshira.com 

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