One of the most frequently asked questions about doing business with China is the banking system and repatriating money: Duncan Levesley of Grant Thornton explains
While British companies continue to sell more and more products and services in China across an ever-growing range of sectors and niches, one issue that most face is ensuring that the money they make from Chinese customers finds its way back to the UK. There are a number of possible pinch points in the process, so here we look at a few of the key issues, including banking and foreign exchange controls, ensuring tax compliance, currency risk and recovering debts.
Banking and foreign exchange issues
China still operates certain foreign exchange controls, and banks are expected to ensure compliance with these rules when facilitating remittances out of the country. As such, the procedures they follow have a major bearing on the process of repatriating profits and getting paid. Overseas companies are not able to open full ‘on shore’ bank accounts in China, and typically British firms trading directly with China will be receiving payment into their UK bank accounts from their Chinese counterparties. This can be a driver for some companies to set up a local entity with a domestic account, but even for those with subsidiaries in China, making inter-company payments to repatriate funds back to the parent company will involve engaging with this remittance process.
Remittances out of China are categorised as either “trade” or “non-trade” items. Trade items, generally meaning buy-sell transactions, tend to be comparatively straight forward, though they still need to be validated through supporting evidence such as customs clearance documents.
Non-trade items, which includes things like service fees and royalties, can be more complicated and are subject to additional scrutiny by both the banks and the tax authorities before payments are permitted. If supporting documents are prepared, and presented where required, the remittance process can be relatively smooth. This notably includes evidence that the appropriate taxes have been accounted for through a tax clearance certificate and a record filing form (for payments above USD 50,000), so an understanding of the relevant taxes is fundamental for payments to be processed, as well as ensuring that the expected amount is received in full. It is worth noting that during the pandemic, banks have increased the amount of documentation they have asked to review, including explanations of business models and transfer pricing arrangements.
These documents may also be reviewed by the tax authorities. This is usually through a ‘post-administration’ process, where after annual corporate income tax filings are submitted, the supporting documents are reviewed to ensure compliance. If the document requirements cannot be fulfilled, a tax deduction for the payment may not be allowed. It is also worth noting that in some parts of China, the tax authorities still want to review the details before the remittance is made.
The VAT system in China is not dissimilar to the UK, but understanding whether the client is going to be able to claim VAT back, and agreeing on who will bear the cost, remains an issue many companies do not discuss early enough in negotiations. There are different rates on goods and services, and for companies that sell a combination of the two, this can be an important distinction. For those selling goods, customs duties also need to be assessed and can be an even bigger issue for some products. This remains a tax that many firms do not look closely enough at. The sums involved can be significant, and as well as being costly, getting it wrong can also create delays in importing products.
Understanding whether the client is going to be able to claim VAT back, and agreeing who will bear the cost remains an issue many companies do not discuss early enough in negotiations
Withholding taxes, which can be levied on payments relating to services, royalties, interest or dividends, is another tax area that too many companies only get to grips with late in the sales process. The Chinese customer will act as withholding agent and pay any tax due over to the Chinese tax authorities, meaning the UK company only receives the net amount. To avoid surprises, contracts should make it clear who bears this cost, and it goes without saying that to agree this, it is usually helpful to know how much it will be, and if there might be any double tax relief available in the UK.
The withholding tax rates can be different for different forms of income, so clarity on all sides as to the nature of payments is important. In practice, whether a payment is for a service or a royalty might not be as clear cut as it sounds. Withholding tax on services can also depend on whether a taxable presence has been created by having boots on the ground in China, and firms need to look at the specific activities they are undertaking, where they are doing it, and for how long.
Managing risk and disputes
As banks will not allow remittances to be made without evidence that the appropriate taxes have been withheld, a dispute over this issue could delay receipt of payment. While the prospect of disputes may be lower when inter-company payments are being made (no one likes fighting with themselves), these same processes are relevant. In addition, transfer pricing will be looked at to assess if the payments are on ‘arms length’ terms, and the tax authorities may want to review inter-company contracts to assess the arrangements that have been put in place, so robust paperwork can be necessary.
Credit risk is of course another major issue. Recovering debts can be a challenge anywhere, but particularly if the counterparty is on the other side of the world and in a different legal jurisdiction. While the UK and China do have a treaty on mutual legal assistance, which can be useful for evidence gathering and asset tracing, there is no agreement in place for recognising or enforcing court judgements. This means that cases tend to require local litigation, but using the courts can take resources that smaller companies struggle to find, especially with associated costs for legal support, investigation, and interpretation. There are a range of commercial debt collecting agencies that can support, at a price, but it is best to try not to get into the situation in the first place, with careful trade terms, effective due diligence, or even trade finance products.
Currency is another key variable to manage where trade finance products can have a part to play, along with options like offshore RMB accounts. The RMB is not fully convertible, trading against the dollar within a limited band, but movements can still have a big impact on profitability, especially for longer-term contracts.
As always, with all these issues, planning is the key. The specifics of every contract will be different, and will create a unique combination of challenges and risks, but it is rare that something completely new will be faced. Other British firms are doing great business and getting paid efficiently for it. Ensure you are following in their footsteps.
Grant Thornton’s China Britain Business Group can help companies dealing with these issues, and others, as they grow their business in China. Please visit their website for more information and to contact the team.