Moving money in and out of China is generally a tricky endeavor, but lately it’s been trickier than ever. That’s because government views and policies on the matter change with the country’s economic conditions. It also depends on their current attitude toward multinational corporations (MNCs). Both of these can be summed as “not good.”
This problem is compounded by a counterproductive relationship between China regulators and MNCs. MNCs, as well as local Chinese, do not have confidence in the government’s ability and willingness to be consistent and reasonable regarding capital flows and therefore want to get extra capital out of the country. Regulators, fearing excessive outflows of capital, impose restrictions in order retain capital in the country.
Just a few years ago, China, cheered on by the global business community, was loosening capital controls. In fact, back in a 2013, Chinese financial regulatory bodies SAFE (State Administration of Foreign Exchange) and the PBOC (People’s Bank of China) were both testing several schemes where currency could cross the border for both incoming and outgoing transactions.
Back then China was looking to be more international – both for the country and its currency. It was common knowledge that China wanted the RMB to become more of a globally accepted and utilized currency (and ultimately a reserve currency). But at that point, the RMB wasn’t trading freely and was still seeking the International Monetary Fund’s special drawing rights designation (SDR). China also wanted Shanghai to evolve to be a global financial center on par with New York, London, Hong Kong and Singapore. To make this happen, the country couldn’t be perceived as one where cash goes in and never comes out. The country also wanted to become top destination for Asia-based regional treasury centers (RTC).
Four years later it’s a bit of a mixed bag. The RMB does trade freely, and did get the IMF’s SDR designation. Shanghai is still evolving; for example its free trade zone (FTZ) experiment has been deemed a success. But China, via Hong Kong, still lags behind Singapore when it comes to RTCs.
So China has retrenched a bit, starting with regulators who just don’t trust MNCs, according to members of the NeuGroup’s AsiaCFO group. For instance, regulating heavyweight SAFE has almost a “shoot first ask questions later” mentality. By SAFE’s lights, left to themselves, companies will always use transfer pricing to shift profits to low tax jurisdictions and optimize cash flows to where they are most needed or effectively used.
With this in mind, governments like China’s want transparency and honesty in those transactions that represent reasonable and justified business dealings between subsidiaries. According to Vicky Wang, tax partner with Deloitte, SAFE has observed goods coming from overseas entering an FTZ and then immediately exiting the country. It has found that many of these transactions are not legitimate and are therefore applying greater scrutiny to trade and payment practices, including tax audits to validate that appropriate taxes are being paid.
SAFE has also delegated much of its governance and policing to banks. One example is the validation of transactions. Since banks are in the middle of this activity SAFE has required them to validate the legitimacy of trade transactions. SAFE has also given banks quotas for dividend payments that must be distributed to their clients. It is natural for banks to allocate this capacity more generously to their preferred clients. This dynamic will pressure MNCs to carefully choose their banks and concentrate business with them. There is also a considerable difference between the abilities of foreign banks versus local banks. The latter, being state-owned enterprises (SOEs) often display more flexibility with the rules while the foreign banks, fearing the loss of their operating license, will be more likely to follow the letter of the law or rule.
SAFE is also in middle of T&E. Many Chinese subsidiary entities reimburse corporate executives for their expenses associated with traveling to the region in order to have the expense on the local P&L to reduce taxable income. This is permissible if the executive is providing an explicit service. Otherwise, it is questionable by SAFE. It’s recommended that companies have the China entity bear the costs directly vs. through reimbursement.
How SAFE reacts to transactions often depends on if it interprets them to be trade or capital transactions. Normal trading operations are much less restricted than capital transactions. One suggestion Ms. Wang makes to get cash out of the country is to purchase intangible assets such as intellectual property. However, she points out that trademarks are more likely to be classified as capital flow vs. trade. She also recommends accelerating royalty payments in a lump sum distribution that covers multiple years. SAFE views these as trade transactions.
Other methods to get cash out? Ms. Wang gave a number of recommendations for getting cash out of China, breaking them down into two groups, before tax and after tax. She noted that before tax approaches are better and include payments of interest, royalties, service fees as well as purchases of depreciable offshore assets and expense reimbursement. There are limits however. Payments need to be at a reasonable price and must be approved by SAFE and taxes must be paid.
Suffice it to say, managing cash and currency in China is a moving target and certainly not for the faint of heart. It requires constant attention to frequent new rules, maintaining relationships with appropriate banks and regulators and effectively communicating the rules and their impact to HQ. Uncertainty and inconsistency are a hallmark of Chinese regulation and there is no reason to believe that will change in the foreseeable future. MNC finance leaders will therefore need to ebb and flow with the environment to take advantage of windows of opportunity to improve capital positions as they appear.