FINANCE & ECONOMICS - One Country, Two Systems: A Disparity of Financial Complexity


China is found to be one of the most complex jurisdictions in the world of accounting and tax compliance while Hong Kong remains one of the easiest places in which to stay compliant with rules and regulations, according to a new financial index

By Kenny Lau

China is among the most complex countries in Asia Pacific for accounting and tax compliance, ranking 7th globally, and is only slightly less than Vietnam, according to TMF Group’s inaugural Financial Complexity Index 2017. By contrast, Hong Kong is one of the least complex and easiest place for compliance, ranking 91 out of 94 jurisdictions; only the Cayman Islands, BVI and UAE were considered less complex for business across the world.

The Financial Complexity Index was pulled together to help people understand some of the differences to consider when they look to operate internationally. “For example, if people haven’t had the experience of running a finance department in China, it can seem daunting,” says Henry Reynolds, Group Relationship Manager (Strategic Alliances) at TMF, a provider of global business and compliance services.

“There is huge variation between jurisdictions from what systems you have to use, how and where to store data, and how to comply with different tax treatments pertaining to the different way countries administer their tax regimes, he explains. “We used a set of weighted complexity parameters in considering the rules and regulations as well as risks associated with non-compliance in different jurisdictions.”

Most jurisdictions do not consciously decide on their complexity and few want to be complex for the sake of it, Reynolds points out. Rather, it is a balance between control, transparency and the economic backdrop of the country, and how it has evolved to where it is today. How a country has shaped its current landscape is usually driven by a host of factors such as economic, political, technological etc.

Summary of key findings:

  • Among the top 10 jurisdictions in Asia Pacific: Vietnam (5), China (7), and India (10)
  • China’s complexity due to requirements of reporting in Chinese language and currency
  • Stringent regulation in Hong Kong despite being one of the least complex
  • Ongoing automation and digitization of accounting processes and reporting

A Conversation with Experts:

  • Henry Reynolds, TMF Group Relationship Manager, Strategic Alliances
  • Judy Chu, TMF Hong Kong Head of Accounting and Tax
  • Wandy Chan, TMF Group Head of East China

How is a jurisdiction judged to be complex in accounting and tax compliance?

Reynolds: We pulled together a list of 70 detailed questions under four broad themes to give structure to the survey and reflect the key areas we have found important to clients. These were Bookkeeping, Accounting, Tax and Compliance.

Each section reflects the different roles within a finance department: bookkeeping addresses the maintenance of the books; accounting looks at the differences in GAAP and various reporting requirements, tax looks at how to report; and compliance looks at legal structures, roles and responsibilities of directors in both civil and common law jurisdictions.

We then asked our local experts in more than 80 countries to respond to the survey and collected their responses for comparison. The criteria are a culmination of all the questions across all the sub-sections. Most complex would imply less flexibility, more rules and regulation in a stricter environment when complying with the requirements for maintaining, filing and reporting on an entity.

How do we differentiate non-complexity from non-regulation?

Reynolds: Complexity covers a multitude of issues that span the practical steps of being locally compliant. Regulation includes the oversight bodies which vary in how they choose to set the conditions in which the underlying activity takes place as well as the subsequent follow-up to check adherence to the guidelines.

The Financial Complexity Index does not go into the regulatory bodies and how they achieve oversight, but merely how easy it is to comply. It is true that regulation can add to the burden of compliance through additional reports and filings, but it is not necessarily a direct relationship as some regulation requirements are easy to comply with.

The relationship between regulation and complexity (for the purposes of our study) is complex in itself. Both are a blend of the underlying sophistication and size of the economy, cultural stance towards companies, technology available and the amount of control a government wants.

For the purposes of a global survey we have not included the additional industry-specific regulation such as mining, pharmaceutical and banking licenses etc.

The BVI has a low complexity score as a result of the limited number of taxes. This doesn’t mean it is not regulated; indeed, they would say they are well regulated, just that there are limited issues to make the process of compliance complex. Inherently they are a low and effective tax jurisdiction which serves a purpose for international investment such as US pension funds.

What is the correlation between complexity and competitiveness?

Chu: The key driver to competitiveness is not primarily the complexity of the jurisdiction but is driven by commercially strategic issues. Risk plays a large part in terms of economic, political and a host of other risks that international companies face. The drivers for international expansion at an operational level will be to do with their addressable markets and corporate strategy, with administrative burden being more tactical and viewed as a “hygiene factor.”

Hong Kong has many highly compelling attributes that would outweigh an increase in complexity, provided that the changes to the complexity drivers did not impinge on these commercial drivers.

For example, Hong Kong only imposes three direct taxes: profits tax, salary tax and property tax. There is no sales tax/VAT, capital gains tax or withholding tax on dividends and interest. This simple tax system is one of the big attractions of Hong Kong’s business environment for foreign investors.

What makes China’s system so complex?

Chan: China is relatively complex for a host of reasons including: accounting on a cash basis, language, licenced software requirements, and operating licences needed to establish trade as an international company, just to name a few.

And compared to Hong Kong, China has a much more complex tax system, as there is tax imposed on transactions (VAT, consumption tax and business tax), tax on specific objectives (land appreciation tax), as well as tax on resources and property.

China has its own standards which may be difficult for foreign investors to understand. Accrual basis accounting is adapted under the PRCGAAP; however most Chinese accountants apply cash basis due to the VAT system.

The administrative approach in China differs among cities, and this often confuses companies with operations in multiple locations. Due to China’s licensed software requirements, additional investment needs to be factored in for accounting software customization.

How difficult is it to do cross-border businesses between China and Hong Kong, given very different compliance systems?

Chu: Between China and Hong Kong, it is not hard to do cross-border business. China has one of the highest GDP growth rates in Asia-Pacific, supported by fast rises in industrial output, retail sales, fixed assets and property investments.

Hong Kong benefits from its proximity to China, especially from the developing Hong Kong-Zhuhai-Macao Bridge, which provides links between Hong Kong, Zhuhai City and Macao. The double tax treaty between China and Hong Kong also enhances cross-border transactions by providing preferential tax rates on certain types of income.

Are we seeing a global trend of convergence in accounting and tax compliance?

Reynolds: We have seen the desire for convergence in accounting and tax for a number of years with IFRS and with the OCED BEPS program. Certainly, corporate tax transparency is a key agenda item; however, changes take a long time to enact and require the domestic political will to enforce the recommendations.

Despite a global framework, it is still left to individual jurisdictions and countries to decide how to comply – which leaves room for differences in interpretation and methodology of compliance. It is a balance between change and disruption to the current practice against the need for governmental revenue collection and the long-term benefits.