Maintaining Authority Compliance in Your Chinese Subsidiaries: - Meeting The Challenge


By: Alex Wu, Donia Joevion Fuller-Barrett     On: 2016-12-01

The Background

In recent months many foreign companies have experienced an increased scrutiny of their subsidiaries in China. This it is believed coincides with the slowdown in foreign direct investments (FDI) and the Chinese economy in general. Chinese subsidiaries have reported a seeming increase in levels of aggression on the part of Tax Authorities who are believed to be constrained to find additional sources of revenue. Similar levels of intensity are observed in respect of the Administration of Industry and Commerce which has reportedly become more active in identifying and investigating incidence of non-compliance and of course imposing severe fines where breaches are discovered. Not to be outdone is the State Administration of Foreign Exchange which is perceived to have become more stringent in its dealing with overseas payments in foreign currency. The result is that many have begun to question whether their foreign subsidiaries can survive in China and many potential investors express general apprehension in relation to the idea. But is the situation such that foreign companies cannot escape liability for non-compliance?

The Challenge of Maintaining Compliance 

For several reasons, China presents itself as an ideal jurisdiction within which an overseas company can do business. To that end, it is not surprising that there are scores of foreign companies which have Chinese subsidiaries. However, in addition to the concerns highlighted above, the data shows that companies have had experiences of varying degrees of difficulties with maintaining authority compliance in relation to the various authorities with which the subsidiary must interact. Indeed, many have expressed the view that it can be a challenge to maintain authority compliance. The primary reason for this is that some industries have very stringent compliance systems. Therefore approvals may be given which facilitate the lawful execution of one facet of a business. Yet, if any expansion is undertaken, this is viewed as a separate venture in and of itself, requiring a whole different set of compliance matters to be addressed. To exacerbate the concern is the fact that these experiences are not only inconvenient, they are sometimes unpleasant. Moreover, the legal and regulatory framework may at times change in a manner that appears to be ad hoc making compliance genuinely difficult.

Illustrating the Impact of Non-Compliance

Just recently, the manager of a large Northern European Multi-national Corporation (‘MNC’) was detained by local Chinese police pending the clarification of a matter involving authority compliance. In that instance, a product was added to an existing portfolio of industrial components. Noteworthy is that up until this point, there were apparently, no compliance issues. Furthermore, the added product was merely a larger model of the same type of product which was already being produced. However, the relevant checks were not made which would have highlighted the fact that a special “production license” was required for the larger model. Therefore, one decision resulted in the company going outside the scope of its existing, approved business scope, therefore losing its authority compliant status. During an inspection the infraction was discovered resulting in the detention of the company’s legal representative. His release was not secured until a significant sum was paid as a fine and the disruption in service which was experienced is hard to quantify.

The Impact of Failing to Meet Challenge of Authority Compliance

The experience of the company as documented above, is by no means novel or unique. Rather, it speaks to the absence of a systematic approach to compliance documentation in relation to new products, a situation which exists in many MNC’s and Chinese subsidiaries. That the absence of compliance systems is problematic is evident from the results of a study conducted in Shanghai by Asia Base Research – a sister company of Asia Base Law & Projects. The study involved several foreign companies and the results showed that 71% of those analyzed have had at least one incident of noncompliance that took significant amounts of time to achieve a satisfactory resolution. Of these, 26% had to resort to the use of third parties to assist with resolution, and 20% were subject to large fines. In one case a manager was detained on account of the issue of non-compliance. Several of the companies had experienced interruptions to operations while the non-compliance was dealt with.

Thus, in the absence of a systematic method of securing authority compliance, a company runs the risks of being exposed to high fines, loss of production time and in some instances where the infraction may or may not be deemed extreme, detention of the legal representative, who more often than not is a foreign national. In other instances, even if there are no fines, financial losses are inescapable. This is not difficult to envisage when a company has one or more of the following experiences:

  • Problems with import and export due to missing registration documentation;
  • Issues with obtaining loans and payments due to incorrect, incomplete or absent permissions;
  • Problems with remittance of dividend and other inter-company payments due to lack of approvals or wrong approvals;
  • Challenges with delivery due to missing production or product licenses;
  • Issues with insurance companies due to lack of documentation or outdated and/or expired policies;
  • Human resources challenges due to missing or expired employment contracts; as well as
  • Challenges with protecting Intellectual property rights due to absence of the relevant certification.

Meeting the Challenge of Authority Compliance

For the reasons enumerated above, Asia Base Law & Projects has developed its practice as specialists who assist foreign companies located in China to attain and thereafter, maintain authority compliance. Furthermore, we consistently revise our comprehensive compliance management system to meet the evolving challenge of authority compliance. The facet of this system which proves most pragmatic is the fact that it may be performed by a Company without more external assistance. Therefore, compliance need not be considered as an exercise to be dreaded on account of the costfactor.

The first step requires a detailed analysis of the industry requirements in relation to your business and what is necessary in order to meet compliance standards. At this juncture and certainly when this is being done for the first time, the services of a local law or accounting firm are indispensable to the provision of a solid, comprehensive perspective, informed by experience, in relation to what is required. 

The second step involves the implementation of a comprehensive filing system under which required documentation may be divided into nine categories as follows-

  1. Shareholder related documentation (this includes, but may not be limited to investor registrations, Power of Attorneys, appointment of board members, Legal Representative(s) and Supervisor (s));
  2. Company registration documentation (this includes but is not limited to, documentation showing compliance with company registrations, tax and customs registrations, approvals and licenses, capital injection and foreign loan registration);
  3. Operation certificates & permissions (this includes but is not limited to, product registrations, production licenses, special licenses, approvals specific to industry, products, processes and environmental impact assessments);
  4. Facility approvals and permissions (this includes but is not limited to, design approval, construction approval, equipment approvals, safety and hygiene approvals, utility approvals and fire approval);
  5. Board of Directors file (this includes but is not limited to, board meeting agendas, minutes, resolutions and nominations);
  6. Auditors book (this includes but is not limited to assignments, contract, communication records and audit reports);
  7. IPR documents (this includes but is not limited to, Patents, trademarks, copyrights, license agreements and software licenses);
  8. HR related documents (this includes but is not limited to, contracts of employment, contracts concerning independent contractors, social insurance, work permits, residence permits, visas, human resource manuals/policy documents and employee handbooks); and
  9. Insurance cover (which includes, but is not limited to property and risks including 3rd party liability and Employer’s liability, motor vehicle insurance and product liability)

Whilst this 9-pronged filing system is only a recommendation, regardless of how the compliance system is set-up the company then has the duty to ensure that each document required is (i) in existence, (ii) valid in terms of the timeframe which it covers, (iii) up-to-date in relation to the information contained therein and (iv) properly filed to facilitate ease of retrieval in the event it is required on short-time to prove compliance with a regulation or other requirement. Admittedly this part of the process can also be exceptionally tedious, requiring checks and balances for over one hundred documents. To that end, the use of legal services may be prudent.

Fortunately for some, who belatedly adopt our Corporate Compliance Guard system we are able to identify a problem and secure resolution before it becomes an issue. For this and other reasons, our clients compare our Corporate Compliance Guard service to a quality management system like the ISO-9000, with characteristics such as external audit functions to name a few.

Conclusion

Meeting the challenge of authority compliance in China can be exceptionally difficult. The reasons for this are manifold but primarily relate to the manner in which regulations are made, applied and adopted. Indeed, a failure to meet compliance stipulations may result in significant financial losses. This however should not be viewed in an inhibitive manner by either potential market entrants or existing market players. Rather, the solution is the implementation of a systematic compliance system to weather the challenge.