Can your China manager manage?

March 4, 2008 Posted by China Briefing Reading Time: 4 minutes

Local Chinese standards may be eating away at your businesses ability to globally compete

Mar. 4 – Can your China Manager manage? In times when increasing numbers of foreign invested companies in China are localizing – is your Chinese manager really capable of running your multinational business within the law and to global standards?

Consider these points:
1) When working for Chinese businesses, the tax bureau often does not pay as much attention to detail as they do for foreign companies during audits, as a result, fraud and improper financial reporting is rife amongst key executives.

2) Certain practices may be routinely carried out by Chinese managers to beat the system. Payment of invoices into personal bank accounts rather than corporate ones to avoid VAT is common.

3) A lack of regulatory authority in China means Chinese managers are often not properly educated when it comes to understanding or dealing with international standards of transparency.

Shocking? These practices are endemic. In foreign invested companies, where the Chinese manager has joined from a Chinese business, local business practices may be inserted into your business and lead to extreme problems and conflicts with IFRS and SOX stipulations.

Levels of financial scrutiny during audits
China’s tax administration is understaffed, underpaid, and over worked. This means the tax department has had to categorize the levels of scrutiny it places upon the local businesses it is responsible for. Foreign invested businesses are at the highest level of scrutiny. Chinese managers employed by Chinese companies are thus able to do deals with the tax bureau to minimize the amount of tax their business pays.

It is common, we estimate for only 5-20 percent of the actual tax position of a Chinese company to be assessed and payable. Most Chinese managers and business owners will arrange to settle with the tax bureau for a declared amount, saving the tax bureau the hassle of checking the true figures and properly assessing the audit – a time consuming task. If attempted while with a foreign invested business – the tax bureau can report attempts to defraud and demand late payment penalties of up to 5 times any tax amount due. Plus of course the legal position back home directors face for fraudulent activities in their China subsidiary.

The issue over under-declaration of taxes at annual audit time is such a huge one, this author feels it should be brought up with the Chinese government in bilateral talks as the nonpayment of taxes in this way gives Chinese businesses a huge advantage over domestically competing foreign businesses who, at level one scrutiny, are not able to negotiate such massive “tax discounts.”

Beating the system
The payment of taxes in China is largely archaic, and as we have seen, prone to cronyism. In addition, it faces structural problems that in some instances actively encourage fraud, or the manipulation of financial statements. Consider VAT. It is payable by businesses at the end of the month following the issuance of an invoice, and not upon payment for the goods. Consequently, this creates a financial burden for businesses as they must reimburse the government for VAT without having collected on the invoice. Accordingly, it is common practice for goods to be shipped to the customer, and no invoice issued (meaning immediate inventory control problems). The customer may make payment in stages, over several months. Rather than commit the seller to raising an invoice (and thus an immediate VAT liability) the financial manager of the selling company may instruct payment to be made to his or her personal bank account. Then, when the amount in full has been received, transfer the payment to the company account and then issue the VAT invoice for the goods. There are obvious problems and concerns with this, mixing of company and private bank accounts, let alone temptation and financial record keeping inconsistencies. Yet many Chinese managers see nothing wrong with such a system – they were trying to help. Such practices within your own business when hiring staff used to beating the system can have disastrous consequences.

Lack of independent regulatory authority: The managerial glass ceiling
At a more corporate level, a major concern is the existence of a Chinese glass ceiling that Chinese managers, especially those from State-owned enterprises and publicly listed companies hit when transferring to multinationals, either as a career move or via an acquisition. When we note that the Shanghai and Shenzhen bourses are still largely taken up by companies all or partly owned by the government, we must examine the credibility of the regulatory system in China. In fact, the China Securities and Regulatory Commission has no power to punish errant individuals, all such misdemeanors must be passed for prosecution to the State. As employees of State-owned enterprises, and de facto government employees, this has led Chinese managers into poor standards of corporate governance and accountability. They are, in effect, playing in China to rules set in China and are not being educated to any global standards of transparency, ethics or to principles engaged elsewhere. Such personnel can pose a huge risk to a multinational when inserted into a responsible managerial position. They are used to playing to a quite different set of values and accountability from yours. It is imperative your China manager has worked in an environment subject to the standards your company has to abide by; otherwise your corporate integrity can be seriously compromised if he brings with him the previously learnt Chinese standards of corporate transparency.

Communication Skills
A lot of Chinese managers speak and write fluent English. However that does not mean they fully understand the business culture of adhering to global standards. Additionally, while Mandarin Chinese remains the world’s most spoken language, it is commonly spoken in just 7 countries, and the vast majority of speakers reside in Mainland China. When one considers that the second most commonly spoken language now is Hindi (India), third is English, just ahead of Spanish, and fifth is Bengali (India) – Mandarin communication skills may remain vital in China, but are they essential internationally?

When assessing your business as a multinational concern – with international standards of compliance to meet, and a global marketplace to sell too – can your China manager really manage?

Chris Devonshire-Ellis is the publisher of China Briefing and the Senior Partner of Dezan Shira & Associates. He is based in Beijing. For issues relating to HR legal and tax liability in China, please contact him via legal@dezshira.com.