In what might be the regulation that slipped through the traditional media wires, Jay Boyle of EXPAT CFO just forwarded me a potential bombshell of a regulation where China will look to tax all those offshore transactions that investors have come to rely upon when setting up their China vehicles.

… and it went into effect January 1, 2008

In short, the circular is meant to specifically address the offshore sales of China based assets, and Deloitte has already put together their thoughts on what this means for investors (download file here):

Circular 698 makes it clear that the Chinese government intends to tax indirect transfers, many uncertainties still need to be clarified. It is unclear how the 12.5% effective tax rate of the offshore intermediary holding company is to be determined; for example, will the minimum 12.5% rate criterion be met if the jurisdiction of the intermediary company has a tax rate higher than 12.5% but does not tax capital gains? In the case of a direct transfer of a Chinese resident enterprise by a foreign entity, the SAT will easily be able to identify the transferee as the withholding agent; this will be more difficult in the case of an indirect transfer of a Chinese resident enterprise.

It is unclear how the tax bureau will enforce taxation of such offshore transfers in practice. Where transactions involve a large group of companies in a global merger or acquisition, the requirement to disclose all of the information concerning the transaction may create an overwhelming administrative burden and involve the submission of information that will be irrelevant. From the buyer’s perspective, the impact and consequences of a seller’s noncompliance are not entirely clear.

Where I myself am a bit lost in this new “clarification” is the simple fact that the very reason why many firms chose to set up offshore is to effectively dodge authorities who might otherwise block the sale of an asset. That, tax aside, the ability of a firm to sell their HK or BVI shares to another firm without the approvals of Beijing was a huge asset in itself. So much so that those who were able to “clean” a mainland asset and structure it offshore were typically paid a premium for their effort.

An effort that may no longer be enough.

At the same time, my personal opinion is that this clarification will be used as the exception vs. the norm, and that it will be used as a negotiation chip for firms who have found themselves past another red line. Simply getting access to the data in some of the “standard” islands is going to be tough, but if Beijing wanted to force the issue they clearly could under the guise of this law (recognized outside of China or not) as firms would be force to comply or face roadblocks/ fines in other areas.

So, regardless of whether or not we see a team of investigators start opening up the HK books, I think investors would be wise to see that things are getting tighter all around, put down the rose colored glasses, and begin reassessing the risk levels of “traditional” China models.

Any lawyers want to weigh in on this issue?

Update 1: While emailing back/ forth to a Beijing based lawyer, he also was unsure of how the enforcement of this would be possible/ take place, and in my most recent reply to him I asked whether this rule was actually geared for chasing overseas Chinese IPOs vs. domestic M&A.  I do not have his answer yet.

Anyone have thoughts on that possibility?

Wanted to alert everyone to a new Ernst and Young report on Indirect TAxin that is worth the read for everyone.  It is a subject that I have covered here at times when the policies were changing, and this is one of the best reports I have seen to date on how companies view the various taxes (there are 4 indirect taxes in China).

Brought together by Robert Smith (Partner, Indirect Tax) and Kenneth Leung (Associate PArtner, Indirect Tax), the survey/ report explored four areas (I inserted some findings below):

1) Importance of indirect taxes to organizations

• 92% believe that recent changes wil affect their business operations
• 100% acknowledge that managing indirect taxes is important

2) How organizations/ managers are managing the indirect taxes

• Different Indirect taxes require different management (sometimes only finance, sometimes shipping/ logistics, etc)
• 59% said they needed more time and assistance to understand changes

3) Current/ future risks and opportunities

• Mix 100% impact with 59% uncertainty, and you have both risk and opportunity
• Risk is compliance and exposure issue
• Opportunity is ability to caputre savings through full understanding of regulations.

4) Cooperation with Authorities

• overwhelming majority are looking to work closer, as (1) it would help improve their own understanding of the changes and (2) it would provide a chance for firms to engage authorities and tell them how changes impact their businesses.

As was made clear during the VAT rebate overhaul 2 years back, and the recent loosening of many of those categories, these “taxes” have a real impact on business.. and on the bottom line.  As such, I highly suggest you download the report (right click here) and spend some time going over each of the taxes to see where exposure to risk or opportunity may lie.

Good friend, and frequent commenter, Jay Boyle once said that “Guanxi either retires or goes to jail“, and over the past few years in particular we have begun seeing this as Beijing clamps down on a number of officials for graft.

Most recently the removals of Shenzhen Mayor Xu Zongheng and Pi Qiansheng Binhai New Area Investment Zone Director caught my attention as these men were in the drivers seat of major economies, economies that were view as drivers of China’s march to 8% GDP growth.

A few notes of where I find these arrests as important:
1) Many firms when entering China travel from zone to zone looking to find the best deals. Deals that are sometime in contravention with Beijing’s guidelines for incentives. 2 years ago while visiting Suzhou on one such trip were were flatly told that the days of old were gone, and that a new path was being taken. For some, like my client, they chose Suzhou regardless, but for others the search continues further inland. To areas that were reportedly giving better deals.

Deals that could come under inspection

2) The old boys network in Tianjin and Shenzhen are being dismantled, and Beijing wants more control. Tianjin, a city that was only until a few years ago largely managed by those born in Tianjin, Beijing has taken advantages of a few opportunities to dilute this power base and exert its control. for the average firm, in the short term, this may not seem important, however for firms looking to invest at the highest levels or for those firms hoping to skirt the rules, things could change quickly.

Some food for thought on a couple of recent new pieces, and for those with a larger apetite, I highly recommend the article  China’s Governance Crisis and China’s New Leadership

Following the announcement that China plans to establish social security number system,news that China has drafted its first law on social insurance came soon after.

According to the article:

It specifies a common right for citizens, urban and rural alike, to pay premiums and enjoy social insurance for medical care, work injuries, unemployment and childbirth.

The draft highlights more efficient fund management. Governments at municipal, provincial and the state-level should encourage and support the public’s participation in supervising insurance funds.

However, the most important piece of information that I have been able to see is that workers will be able to pay into the system and pull benefits in different locations.  A huge boost for China’s migrant labor, and a key consideration for managers who will be called on to move around China to open new markets.

For firms, the true impact will be largely unknown as there are still a minimum of to readings before this becomes law, but this is surely one of those pieces of regulation that if done right will have a wide impact on China.

China Briefing has just posted SAFE Issues New Regulations to Further Control Foreign Exchange Movement, which confirms the worst case scenario I ran through in my post earlier this month The Next Problem for China’s Exporters: SAFE Regulations.

Confirming what, Michael Pettis’s warned about in his post Hot weather, cold market, I made a trip to the SAFE Homepage to see what I could find, and with the help of google Translate you can get the major points of the document that SAFE posted last week (Google Translation of same page).

Reason for the new rules according to the document is to

“improve monitoring and management of external debt statistics, prevent foreign debt payment risks”.. i.e. reduce the levels of hot money flowing intothe country, and to restrict any potential outflows that may negatively impact the economy (think Thailand June 2007 before the crash on July 2)

and to address this, buyers and investors will be required to clear their money through SAFE before they can spend it, the amount of money that can be cleared at any one time will be limited, if you don’t spend the money within 90 days it must be taken back out, and that to take the money back out it is going to involve an equally painful process.

Now, I don’t think it takes a whiteboard for you to understand the hurdle that has just been put in place for everyone who sources in China.

Effectively, to the best I can tell, cash flow will now be extended at a minimum 30 days.. up to 90 days… and the idea that you need to have a “holding pool” is also now confirmed.

In Pettis’s post he mentioned:

One of my students, whose uncle is a Southern-province-based exporter, told me that he believed (he wasn’t sure) that typically exporters would need to find financing for this period, and since most of them are excluded from commercial bank financing, they would need to take short-term loans from the informal banking sector. This sounds pretty plausible.

From that, here are a few ways to structure this off the top of my head.  I am not sure which is the best in terms of speed, and I am not an accountant/ lawyer so I am not sure how each method would be more/ less in compliance, but here are a few:

1) Set up a WOFE/ Rep Office on the mainland that can establish a bank account and act essentially as a fund manager.  Firms will need to move money in well in advance, clear it, and then put it into this account for future use.  This fund will need to have a safety stock, and need to be well managed, to ensure that any delays in approvals of new funds can be buffered

2) Work with a trusted import/ export firm who will act as your fund.  Depending on the I/E you choose, they may already be the best option as they have a history of bringing in money, pooling it, clearing it, and managing the supplier payments.  The operational issue with this is that you need to give the I/E extra money .. .and backing those funds out is a huge pain.  From a risk perspective, this also adds to the equation as there are stories of I/E firms simply pulling runners

3) ship out a safety stock before Oct 1 that will get you through the end of the year and see what happens.  I am fairly confident that in an attempt to cool off the hot money flowing into this economy, the government is going to find that they are going to have to relent when shown the impact on the manufacturing sector.  this is a nuclear option on hot money (yes… we should be worried)and the innocents appear to be small to medium sized firms (Chinese and foreign)… and the relevant agencies are surely going to be hearing about it.

Things you should do:
1)Read the posts that China Briefing and Michael Petis have put online, to understand the issue
2) Call your accountant, your China based partner, your import/ export partners, etc and work out your exposure.
3) Call your freight forwarder and book vessels in the Sept 20 – Oct 1 time frame.  I can guarantee you that there will be a massive push that week, and you are really better off booking early.
4) If you are still confused, or you are still looking to learn more, check out the SAFE organized training event.  There appear to be a few of them starting next week, and the contact information that I was able to find on the event was:

Contact:, Zhang Wei
Tel: 010-68573886 (Zhang Wei)

Of course, if you have a different work around please email me or comment below.

I would like to post details that allow others to develop work arounds.  I promise… no details that would let anyone work out who it is.

For those of you who were alseep last year, there was an issue related to quality control and product safety that rocked US consumers and gave everyone at CNN something to talk about.

My position at the time was that it was firms like Mattel and FTS tire Import who were to blame for not investing in their quality control platform.  Wasn’t a popular position to take at the time, but sure enough… Mattel apologized for their role.

For the 2008 Christmas season though, I have a feeling that we will all be able to look back and point out the recent decision to stop issuing F visas from July 20 to September 20 as the primary culprit.

All fluff aside, I spoke to several people in HK last week wihle I was there about how the visa policy had impacted them (they were in social compliance/ factory audit groups)… and their only comment was that they were glad they had the F visa as having to get a tourist visa every few days was going to be a real issue for many inspectors who operate from HK and go into Dongguan and Shenzhen for inspections.

Another impact that I have heard of – and it is something BOCOG must be hearing about on a daily basis – is that many of those packages that sponsors are given to entertain clients on the Olypmic green are largely going to waste becuase people cannot get the visas.

Looks like the 400m hurdles just got jacked up another notch.

Good friend of mine sent me an email this morning alerting me to an issue that they were discussing, the SAFE regulations that are set to hit the market next week. Where he ended the email with:

As for the new SAFE regulations for monitoring forex from trade, they don’t take effect until July 14. Presumably importers won’t be facing delays until then

As you may have read, heard, or remember… there has been a huge amount of money coming into China that finds its was into stocks, real estate, bank deposits, etc. It is called hot money, and everyone I have spoken with on the subject – and by all media accounts – the numbers are huge

The problem though, as I am told, is that this money is largely unaccounted for and poses real macro level risks for the economy (what comes in… can go out?), and in an effort to get control of this problem SAFE has enacted a new regulation that will essentially put all money inflows through a process of some sort (I am still looking into the process).

When asking my friend about some resources, he pointed me to the Michael Pettis article Hot weather, cold market, and at this point I would also do the same as it is an excellent article on the topic.. and the post below it covers the hot money issue.

the passage that popped off the page for me was:

I was discussing with my students over coffee the effect of the new export-management controls on inflows announced Wednesday night (and discussed in Thursday’s entry). We agreed that if these measures are at all effective in seeking out hidden hot money inflows, the monitoring period would probably add a few weeks to the time between when foreigners pay for an exported good and when the cash is actually disbursed to the Chinese exporter.

One of my students, whose uncle is a Southern-province-based exporter, told me that he believed (he wasn’t sure) that typically exporters would need to find financing for this period, and since most of them are excluded from commercial bank financing, they would need to take short-term loans from the informal banking sector. This sounds pretty plausible.

For me, where I see the importance of these paragraphs is that essentially he believes it may take an extra 20 days or so to clear the inbound money, and where this is important is that many manufacturers simply will not move the product until they have been paid in full.

So, where his conversation was of manufacturers out finding bridge loans (something I am trying to understand more), for me the main issue is that international buyers may need to set up a mechanism in China whereby they can idle the money they need for a particular month.. and then backfill.  It will require a lot of planning, more attention to forecasts and budgets, and potentially (depending on one’s current set up) may require a firm to acutally register an entity in China.

PErhaps I am reading it wrong?  But, in the time I have been assisting on trading in China I have never been able to tell my exporting factories that I need 20 days to pay after they ship the goods.  we are not WalMart or GM, and we simply do not have that power..

and I am sure there are others out there in the same position.

So, if anyone out there knows more about this, please post a comment.  5 days isn’t a lot of time to bring together a workaround, but it would be good to understand this more before the deadline comes.

In my post Summer 2007: A Catalyst for Environment Change in China I predicted:

The summer of 2007, will be shown as a turning point in China’s development

and unfortunately for one client, I found out last week that I was right, and their proposed investment in a East coast city is still in a holding pattern after nearly 11 months.

It has been nearly a year since the reports of algae blooms in Wuxi began surfacing, and since that time there have been many who have questioned the longevity of the policies that resulted from that time.

If anything though I think we are seeing a tightening at all levels, and in a wider area that we initially thought. It is a process that has brought changes at many levels.

At the policy level SEPA was given a seat at the highest level, labor laws and visa policies have changed the fundamentals of HR, and investment policies have been introduced to spur higher quality investments

For some, this will be a welcome process that results in an economy better balanced, cleaner, and more sustainable. For others, it will mean policies that conflict with their goals, contradict the old ways – the old promises, and result in short term chaos.

The game has changed in many ways, and it is clear that this process is not finished yet.

So, for those of you who did not heed the warnings of last year, I suggest you reread the following posts again.

1300 Annecdotes Make it a Trend. Clean Up or Close Up

CSR Supply Chain Summit: First Session

If You Are Manufacturing In Beijing, Tianjin, or Shanghai. PAY ATTENTION

Want to Invest in Suzhou? Evaluate Your Impact

In China, as much as a solid market research report can do for you company, so will a solid risk assessment… and that is a step too few undertake.

6 months after I started reporting on the clampdown on visas, it is now a full blown party with major newspapers and blogs all reporting pretty thoroughly on the issue.

A new piece of information that I have to add at what I have already seen at the other sites, that no one else has covered, is that I recently was sitting in a clients office when their HR person gave us some bad news

Anyone born after 1983 can no longer get a Z visa.

What struck me about this was that if true this would represent the first real change in policy. After all, working on an F visa was always outside the rules, and even extending a Z visa to rep office employees was a poorly enforced rule… but but restricting Z visas to those older than 25… THAT IS NEW

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I just love how some are able to see an opportunity to profit (h/t Soni who emailed this link to me earlier this morning).

The Yantai Longharmony Business Development company is now advertising on Alibaba that they can get you the documents you needto get the multiple entry F Visa:

Note: While I can appreciate the humor of this situation, I should remind you that there is a clear procedure for getting F visas… and it doesn’t involve the group above.