VAT is a liability to the tax bureau within a month of the sales invoice being issued. Typically 17% of the sales total, it is supposed to be settled at each month end. Fair enough. However ? when in China does anyone pay within 30 days ? Receivables run into months. There is risk of bad debt. So ? the mere fact of incurring a VAT liability means an immediate reaction to this ? often resulting in the following behavior:

1) Goods being shipped / delivered with no supporting invoices
2) Inventory discrepancies

So you are already out of whack between recorded sales and inventory management just there. Then, let?s assume payment for the goods is received in stages rather than immediate settlement, as is common in China with many businesses trying to cover up operational inefficiencies through manipulating cash flow. There is STILL a reluctance to issue the invoice and acquire the full VAT burden as full payment for the goods has yet to be received.

Common practice therefore is for the Accounting Manager, or General Manager, to open a private bank account, and for the customer?s money to be transferred to this account, instead of the company account. When the total amount of receivables has finally been transferred ? the manager then issues the official company invoice to the customer and transfers the monies in his accounts to the company (or should do), who can then in turn settle the VAT portion at the month end without risk. So ? here we uncover a quandary. Is this fraud ? Is it understandable? Does it cause financial / stock control problems? Does it cause audit problems? Is it in compliance ?

When assessing, either your own internal financial controls, or certainly when conducting due diligence on a Chinese business, the likelihood of uncovering such activity is extremely high. So ? what are the risks ?

VAT Cash Flow Risk versus Late Payment Risk

If you invoice upon delivery ? you either get in compliance with the tax regulations and settle at the month end ? and then swallow that burden until the client pays, or you delay payment of VAT. That carries the risk of late payment penalties. Or you enact the scenario above. These can be categorized:

VAT cash flow
I fund the tax bureau 17% until I can collect on the debt in full.

VAT late payment
I delay payment until the client settles. I risk getting into trouble and incurring late payment fines of up to a maximum of 5 times the amount due, plus the original VAT amount.

Chinese style management
I incorporate the system above to minimize 1 and 2, but create financial reporting and audit problems in doing so.

So ? now we begin to see the difficulties of being in compliance in China ? as well as start to understand some of the rationale behind Chinese style management accounting.

To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
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