Benjamin Wey - A China Expert's Views on Understanding SAIC and SEC Filing Discrepancies for U.S. Listed China Based Companies
Recently, some investors interested in investing in U.S. listed China based companies have expressed concerns over discrepancies found sometimes in the financial statements between certain Chinese companies' State Administration for Industry and Commerce (SAIC) filings in China and their U.S. SEC filings. Investors often quickly conclude that the underlying China operating entities must be fraudulent in inflating sales and earnings figures, and that their public SEC filings in the U.S. may not be relied upon for accuracy.
On the contrary, it is highly unusual and it should cause real concerns to investors if SAIC filings DO match a public company's SEC filings.
Based on New York Global Group's 12 year office presence in China as well as our deep understanding of the Chinese business practices, culture, and language, the concerns over SAIC and SEC filing mismatches are overblown and unnecessary. The reason is simple: investors lack basic understanding of China's corporate registration processes and are comparing very different items. It is important to understand what these documents are, what they are not, and why it would be incorrect and ignorant to allege companies as frauds based on SAIC documents. This article intends to alleviate these concerns based on facts and our extensive knowledge of China.
There are over 50 million registered businesses in China. China's State Administration for Industry and Commerce ("SAIC") has no authority in overseeing the financials of a business in China.
It is incorrect to refer to SAIC filings as a Chinese company's "tax authority" and make accompanying accusations regarding tax evasion or derive judgment on a company's financial status. The SAIC's function is like the "Office of the Secretary of State" at the state levels in the U.S., whose primary responsibilities include business registration, issuing permits, and maintaining corporate status of a business. Here is how it works: Chinese companies are required to file annual tax returns with local tax bureaus. The same filing document is copied to the local SAIC branch office within the jurisdiction where a business is physically located. What does the SAIC office do with the documentation? It gets filed away and there is nothing more beyond that. The process is a simple formality to show that a registered business has filed its annual tax returns, which is a requirement for a business to maintain good corporate standing. In addition, SAIC has tens of thousands of branch offices across China that each provides varying lengths of information solely related to a business's registration status. There are more than 50 million registered businesses in China and all of them must register with their SAIC local branch offices before they can start doing business.
For a Chinese company, a "Certificate of Tax Completion" is all that is needed to satisfy a company's tax and annual financial filing requirements
State Administration of Taxation ("SAT") is the only Chinese government agency that has the legal authority to collect corporate taxes and receives annual financial reports of a business. SAT has tens of thousands of local branch offices across China. Corporate tax reporting in China is a local event, filed by a business within the jurisdiction of an SAT office where the business is physically located. Once a business makes its tax filings, the local SAT office issues a "Certificate of Tax Completion" to the business which provides evidence that its tax filings are complete and accepted, and that the business has satisfied all of its tax and financial reporting obligations. Then a copy of such filings is provided to the SAIC office which can certify that the business is in good corporate standing. That is the very extent of the SAIC's involvement in Chinese tax filings.
All of the U.S. listed China based companies are under holding company structures which own multiple subsidiaries in China. Unlike the SEC, the SAT or SAIC does not require a holding company to file consolidated financial statements.
If a company is a holding company that owns multiple subsidiaries or factories that are not all located in the same physical location, then each subsidiary has to file its own tax returns separately with a local tax bureau where the subsidiary is located. Each subsidiary makes its own tax filings independently from other sister businesses as well. There is no such a thing as a consolidated tax return filed with either the SAT or SAIC at the holding company level. Therefore, for a holding company that owns multiple subsidiaries, pulling a tax return on one subsidiary certainly does not represent the holding company's financials. In the case of U.S. listed China based companies; all of them have multiple subsidiaries located in China. Until all of a holding company's subsidiaries are consolidated into one financial statement, simply adding up the financials of each subsidiary does not equate to the financials filed by the holding company, represented as an entire organization through its SEC filings.
On the other hand, a holding company's auditor reconciles tax filings, sales receipts, and other public and nonpublic financial evidence to produce SEC and U.S. GAAP required financial statements. Experienced auditors in China are well aware of this issue. Further, adjustments are made for differences between U.S. and Chinese GAAP. Thus, SEC filings are indeed the most reliable proxy for a U.S. listed company's financial performance.
A company's tax filings with a local tax authority cannot be obtained by non-related third parties through legal means. By law, business tax filings are not publicly accessible.
It would be impossible for anyone outside a business itself to have legal access to its SAT tax filings since the data is not publicly available and confidentiality is strictly preserved by the Chinese government agency. It is certainly illegal and a criminal act to trade or disperse rumors based on such nonpublic information. Many so-called China "sources", often backed by stock short sellers, tout their abilities to get purported financial reports filed with the SAT on any U.S. listed China based company. These are illegal claims. Also as discussed earlier, no consolidated financial statements exist for a holding company in China. Even if an SAIC filing is illegally obtained on a subsidiary, it does not reflect the U.S. listed holding company's consolidated financials.
SAIC filings are not consolidated financial statements and each subsidiary often includes inter-company transactions.
As an example, for a vertically integrated manufacturing business, it is common for subsidiaries to transfer revenues and expenses within the same organization for allocating profits to entities that are legally subject to lower tax rates or for the purpose of simply following a manufacturing production process. To avoid double counting, professional auditors consolidate all of a holding company's subsidiary financials after inter-company transactions are eliminated. A holding company's financials are filed with the SEC only after such inter-company related transactions are eliminated. Therefore, financial reports obtained from SAIC or SAT are absolutely not correct reflection of a publicly traded holding company's financial statements.
SAIC filings have no relevance to the credibility of a company's public filings filed with the SEC
As long as a holding company structure is involved, the SAIC and SEC numbers cannot possibly match except under an extreme circumstance in which a public company has only one wholly owned operating subsidiary and there are no inter-company transactions of any sort, including expenses, different revenue recognitions under Chinese and U.S. GAAP accounting etc. at the parent company level. Presently, no such China based company exists on any U.S. stock exchange.
Any concern over SAIC filings is just one example of the many areas that investors are just beginning to learn about Chinese business practices. Be wary of less professional advice from amateur or anonymous sources that often have untold self-interest behind some seemingly legitimate arguments. There are often stock short sellers behind many "sudden discoveries of fraud" at a legitimate publicly traded China based company. Avoiding fraud involves much more than comparing apples to oranges. Understanding China, learning to speak the Chinese language, gaining better understanding of China's complex cultural and business aspects are among the right steps one should take.
At New York Global Group, our 16 year experience in executing more than 200 China related projects has helped us identify traits that are fundamentally critical for strong companies with strong corporate governance. Due to our stringent client acceptance criteria, we accept only 1% of the hundreds of China based companies that we review each year as clients.
About the Author:
Mr. Benjamin Wey is a bi-lingual expert on China and the President of New York Global Group ("NYGG"), a leading middle market advisory firm on Wall Street specialized in executing China related transactions. With access to over US$500 million of investment capital and more than 80 professionals between New York City and Beijing, NYGG has been advising China based corporate clients with their strategic growth in the past 16 years. NYGG is a leading source of high quality deal flow for investment banks and institutional investors worldwide. A Chinese American, Mr. Wey possesses extensive international business experience, broad business contacts, and cultural understanding as an expert on China. In 2006, Mr. Wey was awarded the Golden Key to the city of Suning, in China's Hebei Province, for his leadership in establishing a 120-student elementary school benefiting underprivileged kids in rural farming communities and orphans. Mr. Wey came to the United States in his teenage years on a full academic scholarship. Mr. Wey has a Bachelor's degree in Management and an MBA in Finance. Mr. Wey is a Visiting Professor of Finance at Shanghai University of Finance and Economics as well as China University of Petroleum. Mr. Wey is currently the Executive Director of China Investment Association, an affiliated entity of China's National Development and Reform Commission (NDRC).
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