Xiaomi, Tech Companies Face Crackdown By Chinese Tax Authorities

Xiaomi isn't the only company in hot water with Chinese authorities.

China smartphone maker Xiaomi Corp is the latest company to be taken to task by Chinese regulators in a trend that has some analystsworried.

In a statement this month, China’s Ministry of Finance said the Hong Kong-listed tech giant had made accounting errors, incorrectly recorded tax on corporate gifts and failed to standardise the reimbursement on corporate expenses.

The public censure of Xiaomi over its practices—which Xiaomi has says it has since rectified—is part of a broader crackdown on shoddy tax accounting that has affected tech companies with overseas assets. Others firms that have come in for condemnation include e-commerce firm Suning and games maker Wuhu Shunrong Sanqi Interactive.

“The Ministry has accused a whole slew of Chinese companies of tax evasion through their foreign operations, Xiaomi was just one of many,” explains Steve Dickinson, an attorney with law firm Harris Brocken which specialises in China law.

Dickinson notes that where the Chinese government once encouraged domestic businesses to expand operations overseas, it is now trying to stop the flow of capital going abroad as companies shiftincome out of China to lower tax jurisdictions. In some cases, the government has turned to extreme measures.

“Rather than bringing a normal legal proceeding, the government turns to these public accusations and disappearances to address the situation,” says Dickinson. “Companies like Xiaomi and Suning are dead in the crosshairs of a very rapacious regime that is trying to extract every cent of tax they can to put of business so they can be taken over by a state-owned enterprise.”

Not everyone sees the recent news through the same lens. Ji Li, a professor specializing in Chinese law and politics atRutgers Law School in New Jersey explains that, contrary to perception, the regulator’s actions are is more of a knee-jerk response than a coordinated campaign. Rather, the crackdown is a reactive move by agencies looking to salvage lost tax revenue.

“The Chinese state is, unlike what the conventional view depicts, quite fragmented,” he explains. “Different state agencies have different departmental interests and motives. Recently the Ministry of Finance and the State Tax Administration, and their local counterparts, are probably under enormous pressure to meet set goals of revenue collection under a slacking economy. Hence the heightened scrutiny from these agencies. But I haven’t seen credible evidence suggesting regulatory tightening across the board.”

Nevertheless, there will likely be consequences for the way Chinese businesses operate in future. Li adds that some sectors, where companies once engaged in aggressive tax planning, may see some significant practice changes in the current environment. If the enforcement is tightened, he adds, the effective tax rate will go up. As a result, businesses will either go under or push for lowering corporate tax rates.

“Compliance in China is often a matter of negotiation. As a result, I don’t think there will be any abrupt change in the investment environment due solely to enhanced enforcement efforts of one or two state agencies,” says Li.

Harris Brocken’s Dickinson is less sanguine, saying the crackdown is “a big deal” where businesses are being aggressively pursued. This should be worrying for companies in the crosshairs, like Xiaomi.

“The primary sector being targeted is the network sector, internet operators and phone makers,” he says. “Foreign companies can’t participate in that sector so it doesn’t have a big effect on US companies, but the companies being targeted could ultimately be taken over by the Chinese government. It shows that the Chinese government will start using very aggressive tax enforcement measures to try to make those companies pay more tax.”