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The Risks of Doing Business in China

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The Risks of Doing Business in China
Despite recent measures to curb corruption, foreign investors doing business in China must remain vigilant.
Tuesday, June 04, 2013 , By Jim Barratt and Jimmy Ko China's economy is the second-largest in the world and continues to grow at an astonishing rate. Just recently, in fact, the Asian Development Bank forecasted that China's economy will grow by 8.2% this year. However, while economic growth brings business opportunities to all investors, continued widespread corruption in China has affected its government's legitimacy in maintaining prosperity in the region and can bring a multitude of risks to financial services companies that are doing business there.

With China's recent transition to new leadership complete, it has been interesting to observe the ruling party's heightened focus on tackling corruption. Under China's new president, Xi Jinping, it has conducted a visible anti-corruption drive and imposed austerity measures in an effort to curb the display of wealth by government officials and generate goodwill among the Chinese population.

While critics say that the recent measures target only the most conspicuous displays of wealth by government officials, the anti-corruption drive has already netted dozens of officials. Moreover, some perceive that the recent election of Wang Qishan as the new head of China's anti-graft body, the Central Commission for Discipline Inspection (CCDI), signals that the financial sector could be a focus in China's anti-corruption efforts. (Mr. Wang possesses a strong background in finance and economics.)

Whether recent measures will prove to be successful in curbing government corruption remains to be seen, as we are all aware that it has been a systemic issue for a long time. For example, the China Securities Regulatory Commission (CSRC), the equivalent of the U.S. Securities and Exchange Commission (SEC), is still perceived as corrupt, despite the arrest and sentencing of a number of CSRC officials in recent years. There have been numerous allegations, for instance, that companies needed to bribe CSRS officials in order to get listed on the Shanghai or Shenzhen stock exchanges.

Regardless of the success or failure of these anti-corruption reforms, if you are doing business in China, you must remain vigilant in minimizing corruption risks. This is especially true for foreign investors: companies that operate in China and have business ties with the United States or the United Kingdom may be subject to the requirements of two of the most significant laws currently existing in the anti-corruption arena: the U.S. Foreign Corrupt Practices Act (FCPA) and/or the U.K. Bribery Act.

Risky Business Practices

In China, any of the following common business practices could put you at risk:
Guanxi and Giving Face. If you have done business in China, you will probably have heard of "guanxi" -- or relationship building -- as the key to getting things done. Guanxi is also built on the exchange of favors. For example, Chinese government officials often expect to receive a "contribution" for using their powers to "provide convenience" -- such as supplying utilities, granting licenses or approving bank loans.

"Giving face" is another important concept when conducting business in China. It essentially means paying proper respect. While it is often well intentioned, giving face can manifest itself in the form of lavish dinners and acquiescing to customer requests, without adequate consideration to legal and moral boundaries.

It is easy to see how a combination of guanxi and giving face could create a situation where it is considered disrespectful if gifts are not provided, with this in turn affecting your company's guanxi with government officials.

As a foreign investor in China, it is critical for you to have an appreciation of deep-seated and long-standing business practices, as well as how those practices may drive the apparent lavish spending on meals, entertainment and gifts.

Fapiaos for Sale? Tax evasion in China is pandemic. Recent estimates put the amount as high as one trillion Yuan (USD 157 billion) per year, and one common tax-evading practice is the use of falsified receipts.

The government endorses the use of a fapiao, which is an official receipt that can serve as final proof-of-purchase of goods and services. However, in an effort to reduce taxes paid, some individuals purchase fapiaos from different vendors at a fraction of their face value, obscuring their true cost of purchasing goods and services.

In some instances, an individual can obtain false fapiaos for the cost of about one percent of the total receipt amount, which means that the business may pay one Yuan for every 100 Yuan that it intends to show on the books.

Given the current zeal for combating tax evasion, coupled with the Chinese tax authorities' focus on foreign companies and joint ventures, tax evasion practices among Chinese companies might expose foreign investors to significant fines and government scrutiny.

Weak Internal Controls. Traditionally, Chinese people treat their superiors with enormous respect and are very reluctant to speak up and challenge them. Combined with the commonplace lack of separation of management's personal wealth from a company's assets, this behaviour can create an environment for management to "do as they please." Anything from the creation of multiple sets of books and related party transactions to undetected (or unquestioned) illegal payments that are "off the books" could happen.

It is important to keep in mind that there are numerous ways that a company can breach FCPA requirements to keep "accurate" books and records and to maintain an "effective" system of internal controls. However, while corruption risk is real and serious for any company doing business and investing in China, taking preventative steps -- e.g., keeping abreast of the potential issues and scams, conducting meaningful risk assessments and improving internal controls -- can help mitigate this risk.

Use of Third-Party Agents. The use of third-party agents can pose the single most serious risk for organizations operating in China. Managers, directors and company boards cannot simply concern themselves with the actions of their own employees while ignoring the actions of retained third parties. In fact, an overwhelming majority of recent FCPA charges related to China stem from the use of third parties who have funneled cash to government officials.

One of the essential ways to manage the third-party risk is to understand the parties with whom you are actually doing business. Conducting adequate due diligence on third parties in China can be challenging but is critical: for example, understanding the ownership of a third-party supplier.

Monitoring ongoing activities is also an important task that is sometimes neglected if positive results are being achieved. Another good practice is to establish solid policies with regard to the retention and compensation of third parties. This should include relevant anti-bribery and corruption contract provisions and communication of company policies to third parties.

You may be faced with a situation where there are no written contracts with third-party agents or where the contractual description of services may be too vague from a legal standpoint, such as a "technical services contract." In addition, you may face situations where third-party agents have used multiple business names or attempted to reclassify themselves as "distributors" in order to avoid certain due diligence efforts by the company.

Reducing Risk Exposure via Effective Risk Assessments
Carrying out anti-bribery and corruption risk assessments properly can be a cost-effective means of identifying potentially problematic transactions, as well as deficiencies in internal controls. An effective risk assessment allows the company to direct limited resources to improve internal controls and mitigate the higher-level risk areas.

A company that has stronger internal controls will be in better position to address litigation risk with regulatory authorities in the unfortunate instance that bribery issues do develop. To illustrate this, the U.S. Department of Justice (DOJ) recently declined to prosecute Morgan Stanley on FCPA charges because it ruled that the company "maintained a system of internal controls which provided reasonable assurances that its employees were not bribing government officials."

Although fraud and bribery in China will continue to be a complicated and challenging issue, companies canstill be in a good position to mitigate corruption risks and prosper in the Chinese economy if they employ robust anti-corruption programs -- including third-party due diligence and management, effective risk assessments and enhanced internal controls.

Jim Barratt (CPA, CFF, CCEP) and Jimmy Ko (CPA, CFE, CMA) are members of Forensic Risk Alliance, an expert provider of forensic accounting services and data protection advice.

Risks to doing business in India
David Cameron has intervened on behalf of two British companies with problems in India, Cairn Energy and Vodafone, by writing to the country's prime minister. He cited unpredictable government decisions as his concern. Here are some of the biggest risks to companies looking to do business in India:
Political risk
Prime Minister Manmohan Singh's administration has been weakened by a series of alleged corruption scandals, and soaring food and fuel prices are also undermining popular support for his Congress party.
Decision making has been paralysed for months. The opposition party is demanding a cross-party investigation of the corruption allegations before it will let India's parliament start work again.
State elections are coming up, and if the Congress party and its allies are beaten, the ruling coalition will be even weaker. That would make it unlikely reform laws will be passed before 2014's general election.
Telecoms disruption
Police are investigating alleged corruption in the award of mobile phone licenses, and have called in a number of high-profile executives for questioning, including the billionaire Anil Ambani, head of Reliance Communications.
Foreign investors in India's phone companies have been rattled, and $900m (£555m) has been pulled out of the Indian stock market on concern mobile phone licenses could be revoked or renegotiations forced.
Separately, India's tax authorities have ordered Vodafone to pay $2.6bn in capital gains taxes (CGT) on its purchase of a stake in local phone company Hutchison Essar in 2007.
Vodafone has said it should not pay tax in India on the deal, but a local judge ruled in September that the mobile phone giant should have paid CGT because the transfer of Indian assets was involved.
Inflation in India was running at 8.23pc in January, well above the central bank's target of 5-6pc. The central bank has said its main aim is getting that under control, and interest rates are now expected to rise faster than previously anticipated.
That in turn could slow down India's growth: interest rates have already risen seven times since last March, by a total of 175 basis points.
Higher food and fuel prices are behind the jump in inflation. The onion harvest failed in parts of the country, causing the price of the key curry ingredient to double. There has also been a proposal for the government to provide cheap grain to the poor.

India and Pakistan are due to restart peace negotiations this month, a move backed by the US which wants Pakistani troops to be released from guarding the Indian border in order to control the Afghan frontier.
There is also the unresolved dispute over Kashmir.
Both conflicts make India vulnerable to acts of terrorism like the Mumbai attacks in 2008.

Doing Business in China; Opportunities in a Major Emerging Market
October 03, 2011
China, a land in the midst of dynamic internal changes, offers unparalleled opportunities to the well-prepared company or individual seeking to expand overseas.
The Chinese government is working to bring its massive population into a modern market-driven economy, and, in the process, opportunities abound for businesses ranging from multinational corporations to budding entrepreneurs. The Chinese government believes that opening their economy to overseas investors is a viable pathway to modernization, and it will help the well-prepared businesses and individuals avail themselves of unprecedented opportunities.
The key point is being well prepared, and the savvy business will prepare for a China venture by working with a highly skilled team, including tax experts, accountants and business attorneys. A primary requirement before embarking on a business venture in China is that the team should include members who are fluent in Mandarin Chinese.
In addition to assembling a team of multilingual financial experts, it is also necessary to understand the Chinese system of taxes and fees. The Chinese corporate income tax – roughly 25 percent compared to the 35 percent rate in the US – is an attractive factor when doing business in China, but is only one of many tax categories that will be encountered.
Your team will be required to understand the tax structure for Non-Resident Companies (NRC's) including Value Added Taxes, Turnover Taxes, Taxation of Related Party Transactions and exempt organizations, to name just a few. China views every business venture as a partnership, socially and legally, thus it is essential to go into negotiations assisted by experts who can provide a comprehensive review of the Chinese tax structure and successful negotiation strategies, as well as understanding Chinese social issues.
One key issue to be understood before embarking on a business venture in China is that while the types and rates of various taxes are set by the central government, local tax authorities will be involved with hands-on matters and company officials should be aware that they often will deal directly with local officials.
Experienced China business veterans note that when entering negotiations in China, a sponsor, usually from within the government, is a requirement. An insider on your team will save dollars and time and help avoid potential pitfalls. BlumShapiro for instance, is a member of Baker Tilly International, a worldwide business network which has China-based member firms that can provide invaluable assistance as our clients successfully navigate the complicated business regulations and tax issues.

Newcomers to doing business with China should also be familiar with the culture, and how social rules impact the business practices they will encounter. For instance it is common for the host country's representatives to press for concessions from potential business partners.
It should be understood, however, that promises made in negotiations, regardless of whether during an introductory luncheon meeting or a final round of contract issues, are expected to be honored. The unwary newcomer could innocently make a promise based on the U.S. tax structure that could prove to be costly under the Chinese tax system so in any negotiations it is essential to be assisted by team members who understand the full implications of every conversation.
It also helps to understand Chinese demographics when reaching out to the potentially lucrative Chinese markets. China has a population of 1.3 billion people but 60 percent of that 1.3 billion, or 780 million people, are classified as rural farmers who are not likely to be part of marketing ventures.
Another 25 percent of the Chinese population is classified as "workers," non-rural people who run the gamut from minimum wage jobs to skilled laborers who earn a decent wage by Chinese standards. The Chinese working class may be a source of revenue depending on the product or service offered.
The Chinese middle class amounts to only 8 percent of the population, with another 4 percent classified as businessmen and senior managers and 3 percent work for the government. But this 15 percent has complete control and most of the money in China, and totals nearly 200 million people.
Firms that are properly prepared to successfully navigate the path to opening serious negotiations with Chinese business representatives could find that an exciting new market has opened for them.
The successful team of accountants, attorneys, linguists and international business experts will labor long and hard, but diligence and attention to detail can position your firm to tap into markets that are all but impossible to access in most of the rest of the world.

’Huge opportunities’ for NZ firms doing business in India
Friday, 16 August 2013, 11:47 am

ANZ has released its second Insight paper on doing business in India, highlighting the opportunities for New Zealand businesses in protein exports, education and tourism.

The paper, Thinking India? Think Long Term, was launched at a function in Auckland attended by Members of Parliament Kanwaljit Singh Bakshi and Mark Mitchell, and officials from New Zealand Trade and Enterprise and Ministry of Foreign Affairs and Trade.

Currently, forestry and dairy are New Zealand’s biggest exports to India, New Zealand’s seventh biggest export market and a country whose economy is expected to grow five-fold over the next 20 years.

The insight paper identifies other export sectors with significant potential for New Zealand - agritech, food and beverage, tourism, education, healthcare and construction.

“Since 2008, exports have grown by 160 per cent, to over $900 million, and there is every reason to believe the opportunities will grow further,” said Mark Hiddleston, ANZ General Manager Auckland and Northland, Commercial & Agri.

China for the World
In The China Strategy, Edward Tse, Booz & Company’s Chairman of Greater China, describes how to build the capabilities that business leaders need for operating an integrated China-global strategy.

Tse explains how to tell which Chinese companies can provide the best alliances for particular purposes, what parts of the country to enter first; how to manage Chinese financing; and how to establish a trajectory for growth that profits with the growth of, rather than just fighting against the growth of, the next wave of Chinese competitors.

Tse also discusses flexible “footprints” for locating innovation, manufacturing, and services; the adaptation of brand names in China’s many markets; and the integration of back-office functions between China and the rest of the world.

Additionally, Tse describes how success in China can be applied globally, using the market knowledge, networks of low-cost suppliers, and scientific talent that can be found there as a platform for reaching a worldwide scale.

In the world’s fastest-growing economy, the experience of the last ten years will not be the best guide to the next ten years. Business leaders around the world who want to be successful—not just in China, but anywhere—will need a new China strategy.

A new China strategy does not merely mean a set of plans for doing business in China. Most big companies are already selling to China’s markets and competing against Chinese companies. Many more, even relatively small enterprises, will join them. But a true China strategy is different. It is a one world strategy: a long-range developmental plan for doing business as a global enterprise in which China is a central and integrated component, in a world where China plays a very different role than it has in the past.

Together, the four drivers of change in China—Open China, Competitive China, Official China, and One World—will transform the way in which businesses operate everywhere.

Canon rearrange business strategy in India
Updated: July 3, 2013 22:13
Entry-level compact cameras may soon be a thing of the past as companies like Canon India are dumping basic models, in favour of more advanced ones, in a bid to grapple with the rise of smartphones and a year of potentially flat growth.

According to Alok Bharadwaj, Executive Vice-President, Canon India, the company’s camera business will see no growth this year on account of poor consumer sentiment and stiff competition from the smartphone industry.

“The industry is caught in a peculiar situation…we cannot compete with the rise of smartphone cameras by lowering our prices. We can only go higher, in terms of price, and pack in more advanced features,” said Mr. Bharadwaj, during an interaction with The Hindu on Wednesday.

The company receives 50 per cent of its Rs.1,850 crore revenue from the ‘photography’ business.

“We’ve discontinued our entry-level line of compact cameras, which was priced at Rs. 4,995, starting from this year. In a few years, over 80 per cent of the cameras we sell will be in the over-Rs. 7,000 segment,” he added.

The photography industry, Mr. Bharadwaj said, needed to be more compact, sleeker and attune with technology.

“Over 50 per cent of our models already come with Wi-Fi. Nobody will be surprised, that in the future, all digital cameras will be Internet equipped,” Mr. Bharadwaj said. The silver lining for Canon India and other digital imaging firms such as Xerox is the growth of other verticals such as commercial printing and managed print services.

On Wednesday, the company re-entered the wide format printing business in India, with a tie-up with Monotech Systems Ltd.

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...Case Study Why the telecoms industry is doing business in RMB Telecoms equipment and handset manufacturers like Telco – the representative but fictional example in this case study – recognise that they can only stand out in a tough sector by competing on an international scale. This increasingly means doing business in high-growth emerging markets like China and leveraging RMB to gain that vital competitive advantage. Background Telco, with its Head office based in London, began life as a manufacturer of wire-line equipment for the Western European aerospace sector. Following the privatisation of national telecoms operators from the late 1980s, it refocused its business to supply carriers in Europe and the US. Telco has been an HSBC client for more than ten years, after finding that domestic banks could not match its international expansion strategy. HSBC’s global network supported its exports growth across new markets by supporting all Telco’s export invoices. Rolling waves of telecoms deregulation saw Telco and other suppliers enter the mobile handset market in the 1990s, attracted by the significant growth opportunities. The intense competition and tightening margins in equipment supply – not least the demand from emerging markets – saw Telco make its first trip to China on a sourcing mission for basic components. Building a business In China At the company’s request, HSBC relationship managers helped guide Telco’s entry into China by working with professional......

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Premium Essay


...States and Canada. ("Buffalo Wild Wings, Inc. History", 2004).  Canada is currently the only country other than the United States that Buffalo Wild Wings Operates in. Buffalo Wild Wings is looking for a new venue. Buffalo Wild Wings is looking for a new country to market and present their product. China is seemingly a great choice as other United States based companies are finding great success in their restaurants. Companies such as Kentucky Fried Chicken and McDonalds have seen profitable results from their restaurants in the People’s Republic of China. Buffalo Wild Wings wishes to capitalize on this market and expand the Buffalo Wild Wings brand to the next level. * American fast food chains show surprising success operating in China. Several fast food chains have been very successful in China. Yum! Brands is an American restaurant giant that owns Pizza Hut, Taco Bell, and Kentucky Fried Chicken. This company has had the most success of any multinational restaurant group in the challenging Chinese market ("Localization Key To Yum! Brands' Success In China", 2012). Kentucky Fried Chicken has 140 restaurants in the People's Republic of China. Other companies are following suit in China. Companies such as McDonald's are Kentucky Fried Chicken's primary competitor, even though many Chinese...

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Iron Pump a/S Into China

...countries (Iron Pump, Company). Iron Pump’s core competence is its main focus on production and R&D in the value creation activities (Hill, 2012, p. 425). This knowledge of applications has founded the corner stone of the company. Iron Pump is situated in Herlev, near Copenhagen and has around 100 employees. Iron Pump has an annual revenue exceeding EUR 18 million (Iron Pump, Company). With an ambitious growth strategy and full capability of competing globally, Iron Pump seeks continuous global growth in the future (Iron Pump, Company). In 2003 Iron Pump entered the Chinese market by establishing a representative office in Shanghai (Interview, Iron Pump). This report will focus on expansion of Iron Pump into the Chinese market, but why China? Firstly, with an expected GDP growth exceeding 7,5 percent in 2013, the Chinese economy is steadying, showing new signs of stabilization after a 2 year period of cooling due to the global financial crisis, hindering further globalization of new markets (Reuters, 2013). Secondly, from a more market-oriented point of view for Iron Pump, it is critical that the great majority of the Chinese pump market is driven by centrifugal pumps. In 2011 it accounted for 50.56 percent of the total market revenue reaching USD7.28 billion. Additionally, this trend is expected to increase and reach USD10.20 billion by 2015, a 10,67 percent...

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