China Due Diligence: Double the Fun
July 14th, 2008 | by This is China! |A recent trip through Zhejiang Province reinforced for me the observation that the more things change in China the more they stay the same. I was accompanying a group of clients to open discussions with a couple of Chinese companies on the possibility of the Western company acquiring one or the other. The first target was really out in the middle of nowhere: it’s first factory was in a town that had only a few hundred thousand inhabitants. That’s very small by Chinese standards. The owners of the operation were affable and capable young men who were clearly interested in a cooperation of one sort or another with the Westerners, specifically - they said openly - for technology and management processes.
I had explained to the Westerners before the meeting that most Chinese companies keep two sets of accounting records: one for themselves, and one for the local tax authorities. The first company, though, surprised me in two ways: they were honest about their duplicity, and explained in detail where numbers in the books were just for government consumption; and they had only one set of books – the ones they offered to the tax authorities. All other numbers the Chinese partners kept in their heads and freely related to the Western businessmen. However, when the Western managers asked questions about revenues and profits and depreciation and the like, the foreign executives found themselves quickly frustrated with the lack of clear answers.
A far more mature acquisition target we visited nearer Ningbo wasn’t too much different. Despite how much better-developed its facilities were (taking up nearly 80,000 square meters) than that of the partnership we had just visited, and how well entrenched it was in Western markets, it too had two sets of books. The second set, though, was at least in book form, so the owner could identify line by line in the report to the tax man what lines were true and which were bogus.
Another revelation for the Western team was just how low taxes and social benefits appeared in the books for employees: healthcare, retirement, maternity leave, disability and the like. Instead of the thirty- to forty-percent additional expense to base salary across many provinces, the two companies were paying around three percent. “There are ways to keep these costs low,” the owner of the second factory said without blushing. “Don’t worry,” he encouraged, “you won’t have to pay more than this amount for the employees if you buy the factory.” Of course, I encouraged the client to worry about it.
To Err is Human; Due Diligence is Divine.
3 Responses to “China Due Diligence: Double the Fun”
By Bill on Jul 14, 2008 | Reply
But what we really want to know is:
What are “There are ways to keep these costs low,” ?
By This is China! on Jul 15, 2008 | Reply
Hi, Bill;
One of the most popular ways for Chinese managers to keep the taxes low on salaries of their Chinese employees is to pay out non-taxable subsidies for things like lunch, housing, the weather (yes, there is a subsidy in Suzhou at least for when it gets too hot outside), etc.
Under the new labor law, of course, a Chinese manager would want to fire an employee coming up on his 10th year at the company, as an employer would have to pay a month’s salary for each year after the 10th year to fire the employee.
I’m sure an auditor in China can give you more creative ways managers minimize employment taxes.
By Tim on Jul 16, 2008 | Reply
Sometimes they maintain three books: one for the tax bureau, one for themselves and one for potential investors if they are looking to get acquired. Triple the fun….