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With the opening of the Chinese economy to foreign investments in the past 40 years, China is transforming into a global economic hub. However, with the standardisation of business administration with the International Financial Reporting Standards (IFRS), foreign investors need to be cautious of the differences between the global IFRS and the local Chinese GAAP. In this article, these inconsistencies between IFRS and Chinese GAAP are getting analysed, as well as looking into the optimal preparation for this challenge.
To increase the foreign direct investment (FDI) into the Chinese economy, the Public Republic of China (PRC) implemented special economic zones (SEZs) to further develop towards the biggest global economy. Hence, on the business administration level, this inquires for own accounting rules referred to as the Chinese Accounting Standards (CAS) or the Chinese General Accepted Accounting Principles (Chinese GAAP). While the CAS is implemented to reduce financial fraud or to optimize China’s tax strategy, in an international context the function of IFRS is to streamline international accounting regulations and transparency. Meaning, that the IFRS should be applied on top of the CAS so that the company can both adhere to the international and the local rules. Nowadays, while China starts to converge more with the IFRS principles, the Chinese GAAP still differs from the well-known and familiarized IFRS trademarked by foreign investors.
The organ of the Accounting Regulatory Department of the Ministry of Finance (MoF) is responsible for setting the accounting standards in China. As the previous regulations of the CAS were mainly concerned with sorting a balance sheet of the state-owned industry in the socialist era, the regulations in current years are aimed to reflect the financial status, analyse the operating results, and maintain transparency (for the state). The Chinese GAAP has two subordinate accounting policies:
In 2001, the GAAP initialy included the Accounting Standards for Business enterprises (ASBE01), however, the ASBE01 was in 2006 further transformed into the ASBE06. The ASBE06, which currently is still required for all publicly traded enterprises in China, is the main set of accounting measurements. Luckily, the Chinese GAAP (ASBE06), has key similarities with IFRS. For small-sized business cooperations, there is a special set of accounting measurements called the Accounting Standards for Small-Sized Business Enterprises (ASSBE). This standard can be seen as a merger between IFRS and ASBE06 and has the goal to make it easier for small enterprises to follow the tax regulations and accounting standards.
Knowing that the CAS and IFRS have similarities, it is evident that the foreign investor should be aware of the regulations that differ within these sets of accounting rules. Hereby the differences between the CAS (GAAP) and IFRS:
Whereas the IFRS has the choice to utilize the preferred method of valuating fixed assets, the CAS does not endorse this flexibility. In IFRS, one can opt for re-evaluating the assets or use the historical-cost valuation method. In CAS, only the latter is agreed upon to be used when valuating fixed assets.
Whenever IFRS updates/changes are released, these new IFRS rules are not immediately, and in some cases never, adopted in the CAS. In short, the Ministry of Finance (MoF) will review the latest release of the IFRS and see if it can be adopted into the China business framework. For foreign investors, this means that 1) the IFRS updates are delayed, 2) the IFRS might never be applied and thus results in 3) the IFRS regulations can be different than in other countries. This can lead to serious problems in companies with an overarching implementation of IFRS changes (e.g. software) in all of the subsidiary ventures.
When handling cases of common service in China, the CAS has a more detailed description of the situation. For example, In the case of merging two companies with similar interests and under the control of one entity. The CAS requires a restatement of the figure while IFRS has no specific rules for this situation.
Opposite to the previous point, uncommon situations in China are less detailed than the IFRS counterpart. The Italian-Chinese Chamber of Commerce exemplifies this difference by looking at employee benefit plans. The CAS has no specific rules for staff benefits offered by international firms besides payments in the firm’s stock. In the case of using benefits packages for its subsidiaries, the mother company can get into serious problems and should always have contact with the MoF to address and record such transactions accurately.
The fiscal year of the CAS starts from January 1st, while the start of the fiscal year can be decided by the company when applying IFRS. Regarding IFRS, the year must be 12 consecutive years.
To minimalize the potential risk of conflicts with the law, it is recommended for foreign investors to notice the differences between CAS and IFRS and apply both of the accounting standards in the right way. In this process of familiarizing with CAS, the differences should be known, and the contact between the firm and the Ministry of Finance should be optimal to resolve challenges and uncertainties. Moreover, be aware that the CAS can only be filed in the China language, and that short-cuts in the Chinese accounting world often result in serious delays and non-compliance: further complicating the international business. Thus, in the case of maintaining an overview of both CAS and IFRS, even while it is about 90-95% similar, it is recommended to have (specialized) agencies on your side. With experts on the topic, it is evident that the venture is assisted by experience. This way, the short straw will not be drawn when dealing in an unknown and new business environment.
For more assistance in the field of IFRS, the newest software by Amelkis can support enterprises to customize and analyse data while preserving an overview of the IFRS regulations.
If interested in personal advice regarding international business advice, tax situations or consolidation (in China), Global Connect Admin B.V. can assist you with these challenges due to the rich experience and framework of connections.
When intrigued by the personal IFRS-software solution, Global Connect Consultancy B.V. offers help with the installation, optimization, and customization of the Amelkis software Solution.
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Doing business in Europe means taking into account the many local rules, EU laws and international regulations. It is not unusual to benefit from various tax benefits or to research the best possible tax solutions. However, tax evasion and aggressive tax schemes are highly unwanted and will be fined. Therefore, it is beneficial to look into the DAC6: The EU Mandatory Disclosure Rules for cross-border arrangements. Let’s check if your company is well-prepared for cross-border arrangements.
What is DAC6?
DAC6 is an EU Council Directive that entered into force on 25 June 2018 and is implemented by EU jurisdictions into EU national law. Furthermore, DAC6 amends the cooperation between the EU Member States by focusing on joint actions and audits.
This directive’s primary goal is to harmonize tax rules in Europe by providing tax authorities an early’ warning system’ that notifies potentially aggressive tax planning schemes. Therefore, intermediaries are obligated to disclose potentially aggressive tax planning schemes on cross-border arrangements, otherwise called ‘reportable cross-border arrangements.
Step 1: Check who is required to disclose reportable cross-border arrangements
Intermediaries, and in certain situations, taxpayers, have an obligation to report cross-border arrangements to the authorities. An intermediary may be relieved from its reporting obligation if they can prove that another intermediary has already reported the relevant arrangement. The image below shows an overview of who is required to disclose these arrangements.
Step 2: Check if the arrangement is cross-border and ‘reportable’
For an arrangement to be cross-border, at least one of the participants must be located in more than one EU Member State. There is no reporting obligation if all participants are tax residents in the same jurisdiction or if there is no connection with any EU Member State. However, even an arrangement between two entities from the same EU Member State may be considered cross-border in some cases. A prime example is an EU entity with foreign shareholders. Below is a short overview of examples of non-cross-border and cross-border transactions.
For an arrangement to be reportable, one or more of the DAC6 Hallmarks must be met as set out in Annex IV of the DAC6 Directive. Therefore, a cross-border arrangement will only be reportable if one or more DAC6 Hallmarks are met. These hallmarks are characteristics or features of a cross-border arrangement that may indicate a potentially aggressive tax planning structure. The five categories of the hallmarks set out by the DAC6 directive are:
The ‘arrangements’ mentioned in the hallmarks represent undefined terms included in the five hallmark categories.
Step 3: Do the Main Benefit Test
The intermediary or taxpayer may benefit from a tax advantage when they fulfill the ‘main benefit test.’ However, this tax advantage may only be considered under generic hallmarks of categories A, B, and (some parts of) C.
However, it is crucial to keep in mind that due to the broad scope of the hallmarks, DAC6 creates a risk of under-reporting and over-reporting. Furthermore, there is no consistent interpretative guidance agreed between the EU Member States.
Step 4: Act on time and prepare for penalties
You should report reportable cross-border arrangements through a special reporting form. Each Member State has its tax authority, so it is recommended to check out your local tax authority website. Generally, you must report a reportable cross-border arrangement within thirty days of the earliest of:
In case of non-compliance, such as non-reporting, incomplete or inaccurate information, the relevant intermediary and taxpayer may be subject to penalties. These penalties are up to a maximum of €870,000. In some instances, there will be a criminal prosecution. In other words, it is better to prevent penalties altogether. After all, significant sanctions and reputational risks apply to not only the businesses but also the intermediaries!
As mentioned earlier, there are risks in reporting your cross-border arrangements, such as under- and over-reporting. Meanwhile, many companies either miss out on tax benefits or end up overlooking essential hallmarks. We at Global Connect Admin provide tax advice for many European companies and international companies that have activity in the EU. Do you have any questions regarding the DAC6, (reportable) cross-border arrangements or other vital information to do business successfully? Feel free to send us any questions our way; we would love to assist you.
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