EY Greater China Consumer Products and Retail Sector...

EY Greater China Consumer Products and Retail Sector Journal

May 2017

Eric Chia

PartnerGreater China Consumer Products Sector Co-Leader

Arnold Sun

Partner

Greater China Consumer Products Sector Co-Leader

Dear Friends,

Welcome to this year’s second edition of the EY Greater China Consumer Products and Retail Journal. We have

seen in the past weeks numerous high marks in both political and economic arenas around the world. Thanks to

the efficient and globalized information network, we have been informed almost simultaneously that a) a China-

based social network company is now among the largest market cap high-tech companies in the world, and b) an

e-business tycoon has become the richest person in China.

We have witnessed the successes of a few China-based e-business platforms and they have transitioned

themselves into the global benchmarks, leading not only in size and market share, but also in technologies and

know-hows. The Consumer Products and Retail (CPR) sectors have been heavily utilizing e-platform as a creative

form of channel to boost sales, yet the new channels can be compounded as companies are often reliant on third

parties – typically eCommerce solution providers or digital marketing vendors – to assist them in navigating

through the complexities. While they may be important to business success, such third parties can expose CPR

players to significant risks.

In their recent article, Third-party risk management for consumer products and retail entities, authors Diana

Shin and Crystal Li analyzed the causes of the risks and provided CPR companies with an approach framework, as

well as a health check list for a preliminary diagnosis.

Evidently, CPR companies in China are fighting for growth in an increasingly digital society that is being

transformed by macroeconomic megatrends, mobility of capital and growth in technology. The increased

complexity of the market has in part resulted in an emerging trend – CPR companies are more frequently than

ever to use stock incentive plans to retain and compensate key talent and management employees to grasp or

maintain competitive edges. Authors Freeman Bu, Crystal Zhang and Lucia Zheng have addressed in their article,

China Individual Income Tax: Key industry insights, the key observations to highlight the favorable tax

treatments available and steps companies need to take to comply with regulatory requirements.

Enjoy reading – and we look forward to your feedback

2EY Greater China Consumer Products and Retail Sector Journal |

Third-party risk

management for consumer

products and retail entities

Diana Shin

Partner, Fraud Investigation and Dispute Services

[email protected]

Crystal Li

Senior Manager, Fraud Investigation and Dispute Services

[email protected]

Overview

Despite a slowing economy, China's

consumer confidence has remained

surprisingly resilient over the past few years.

Rising upper-middle class, emerging

millennials, and fast growing e-commerce

provide strong growth potential for the

market. In the meantime, the competitive

landscape of consumer products and retail

(CPR) entities has been changing rapidly.

The CPR sector is being disrupted by new

technology, with faster, more agile

competitors entering the market. Consumer

behavior is changing just as rapidly, with

online buying channels rapidly shifting

control to the consumers and generating

increasingly complex routes to market.


Many of our CPR clients have been embracing this trend by

expanding successfully into new channels ranging from

eCommerce to omni-channel retailing.

The commercial challenges of expanding and developing new

channels can be compounded as companies are often reliant

on third parties to assist them in navigating through the

complexities of this new arena, typical examples of these

third parties could be an eCommerce solution service

provider or a digital marketing service vendor. While they

can often be important to business success, these third

parties can expose our CPR clients to significant risks.

In our real life cases, not only companies in the pharma

sector but also in other sectors like CPR experienced fraud

cases involving use of third parties to facilitate bribery or

corruption.

Companies in the CPR sector have also the characteristics of

using a wide spectrum of third parties, which may include

service vendors, suppliers, distributors, agents or joint

venture partners.

This creates practical challenges in monitoring the

transactions with increasing complex third parties. Third-

party risk is a fundamental business risk that needs to be

considered and managed at the executive level.

Why third-party risks matter to CPR companies and what are the challenges to address third-party risks?

As we understand from a number of case examples,

misconduct by your vendors, suppliers, distributors, agents,

and joint venture partners will not only result in damage

from regulatory fines but could also create supply chain

issues and data breaches.

From our prior “Knowing your third party” survey, the

following depicts the types of third parties representing the

biggest compliance risks :

Recent high-profile enforcement cases have reinforced the

importance of knowing who your third parties are — and what

they are doing. But, in many cases, this is still not happening.

of respondents have no systems or processes in place to manage and monitor third-party relationships

Companies must take a proportionate and risk-based

approach in respect of entities that perform services on their

behalf.

The business implications to our clients are that :

1. For new and on-going business relationships, companies

need to put in place effective procedures and policies to

address third-party risk

► Local companies – what tools and technology are being

used?

► Multinational corporations – how their global policies and

procedures are localized according to the local cultures

and languages?

► Do the existing procedures and policies cover the anti-

bribery/anti-corruption framework, ethics and

compliance environment to retain and maintain third-

party relationships?

2. All new business relationships need to conduct due

diligence

► To what extend should due diligence be conducted?

► Risk profiles can be created to apply more rigorous

investigation for high risk companies?

3. For on-going monitoring of third parties, companies need

to invest resources and leverage business data

effectively

► Has technology been utilized (forensic data analytics) to

gather data across a company to provide intelligence?

► Is frequent compliance audit conducted to maintain full

and transparent information of all business dealings on

behalf of the company?

of respondents believe risks are morelikely to arise from third parties than from internal staff.


A broad set of tools is at the disposal of companies to

prevent and detect third-party breaches. Third-party

integrity diligence, forensic data analytics, and frequent

compliance audits form part of a broad set of risk

management measures to monitor third parties and identify

where there are conflicts of interest.

How to address third-party risks?

We recommend our clients to take a three-pronged

approach :

1. Third-party integrity diligence

2. Use of forensic data analytics

3. Frequent compliance audits

1.Third-party integrity diligence

Companies will need to seek better understanding of the

cultural and business norms, prior incidents of fraud,

previous litigation and adverse press, other non-

performance contracts within the industry and geography,

or the experience of their peers. This information should be

used to develop risk profiles when companies undertake due

diligence on high risk profiled third parties.

Performing third-party due diligence is critical, as it

represents a systematic and consistent effort to vet business

relationships tiered by levels of inquiry based on a thorough

business inventory and risk assessment. It helps to not only

understand the third parties, with whom the company will be

contracting, but also the broader context in which they will

operate.

The EY Integrity Diligence (EY_ID) methodology offers a

tiered strategy for background diligence:

► Quick scan: Online watch-list and adverse media check.

► Level I: Quick scan plus more detailed online company

and executive background research. Performed both

from global diligence talent hubs as well as local

jurisdictions.

► Level II: Level I plus localized public records archive

search (such as local court filings).

► Level III: Level II plus field research such as site visits and

interviews.

Our web-based EY_ID technology platform is a globally

accessible program management tool that helps clients

centrally coordinate this complex diligence process. EY_ID

helps to manage third-party applications, background

diligence results, risk ratings, approvals, compliance

confirmations and contracts in a single repository. It also can

be customized to guide users through a standard decision

tree when evaluating risk factors in diligence. The result is

an interactive decision management tool which also serves

as a searchable archive of diligence activity.

Proper diligence and monitoring not only help reduce the risk

of corruption but related-party transactions and money

laundering. They help safeguard company assets and

reputation. Due diligence should go deep enough to include

the beneficial ownership of the third party and its reputation.

In addition, there must be complete transparency in the way

that the third party is remunerated; not just in its fees or

commissions, but also in its expenses. The leading practice

is that a company’s travel and entertainment expense

policy should be structured to appropriately apply to third

parties. By applying these policies, it may demonstrate to

the regulator that the company has taken efforts in

enforcing its compliance policies, which can potentially

minimize the severity of fines or penalties on the company.


five commonly seen red flags from conducting third-party

due diligence

1. Omission of certain key personnel/shareholders

2. A lack of information or trading history

This factor alone would not rule out start-ups.

3. Business address in a non-commercial zone or at service

office suites

4. Low capitalized company

Supplier companies with a small capital base could be acting

merely as middlemen for undisclosed suppliers, which pose a

further risk.

5. Tampering or irregularities with the tendering process

Acceptance of late bids, bids being accepted despite failings

in technical specifications or scoring, or bids at or very close

to set budgets are examples of this type of red flag.

Case study: Third-party risks - Distributor

Group ABC is a manufacturer of spirits, and it leverages

distributors to facilitate its sales. Group ABC provides sales

rebates to tier-one distributors based on the fulfillment rate

of sales target, and tier-one distributors allocate those

rebates to lower-tier distributors afterwards.

Distributor XYZ successfully became Group ABC’s tier-one

distributor, after going through a simplified due diligence

(“DD”) - which did not include the research on the company’s

shareholders or senior managements. Distributors XYZ

received rebates from Group ABC and embezzled part of

them, which significantly damaged the interests of lower-tier

distributors.

Lower-tier distributors submitted a compliant letter to Group

ABC, and an investigation was carried out. Based on the

company information of Distributor XYZ from public domain,

its sole shareholder shares the same name with the wife of

Group ABC’s Sales Director – which was soon confirmed by

the Group ABC HR.

2. Use of forensic data analytics (“FDA”)

FDA refers to the ability to collect and use data, both

structured (e.g., general ledger or transaction data) and

unstructured (e.g., email, voice or free-text fields in a

database), to prevent, detect, monitor or investigate

potentially improper transactions, events or patterns of

behavior related to misconduct, fraud and noncompliance

issues.

► FDA uses 100% of the available and relevant data to

obtain meaningful insights for investigative, legal,

regulatory, anti-fraud or risk management matters.

► It transforms large volumes of transactional data into

valuable actionable business intelligence within a short

period of time

► FDA assists internal audit and compliance teams to

focus on potentially anomalous transactions across

business functions and enhance their focus of reviews in

times where compliance budgets are being heavily

scrutinized.


Three red flags commonly detected by FDA

1. Multiple suppliers with same address

Shared or similar addresses, contact details or bank

accounts are potential red flags, as are overly close

relationships within a small group of local vendors.

2. Multiple payments just below authorized level

Evidence of unusual data trends could be:

► Split payments to bypass approval thresholds

► Large numbers of one-time vendor payments to

bypass supplier due diligence procedures

► Duplicate payments

► Lack of proper supporting documentation around

vendor set-up, diligence or payments

► Multiple duplication in vendor master files

3. Generic description of expense reimbursement claims of

vendors/distributors

Text mining within databases to identify “concepts” or

generic descriptions can further focus on high risk

transactions.

On the upside, advanced data analytics tools are becoming

mainstream. New technologies and surveillance monitoring

techniques are being developed to help companies manage

current and emerging fraud risks, and there is growing

awareness of FDA's benefits at the executive and board

levels.

When asked about the main benefits of using FDA, 79% of

our respondents in the Global FDA 2016 Survey indicate the

ability to detect fraud that they could not detect before, and

78% indicate earlier fraud detection; however, only 42%

indicate reduced costs of their anti-fraud programs.

What does good like?

Our Global FDA 2016 Survey found those organizations

receiving positive results from FDA have a number of

elements in common. They are more likely to:

A maturing FDA landscape

FDA has evolved considerably over the past two years. In our

2014 Global FDA Survey, we found that, although companies

were deploying some forms of FDA, many were missing

opportunities to leverage emerging advanced tools that

would enable them to greatly strengthen and improve their

risk management and investigative response programs.

Focus on major FDA deployments is growing compared to

our 2014 Global FDA Survey results, with higher levels of

spending on advanced tools and proactive surveillance

monitoring of larger volumes of data from a wider variety of

sources. To get the most out of these sophisticated tools,

organizations are increasing their in-house capabilities as

indicated by a 22% increase in the number of in-house

deployments as compared to the 2014 survey. In response

to this trend, we also see leading technology companies

introducing ant-fraud, surveillance monitoring and insider

threat product offerings designed to address wide varieties

of fraud and litigation risks across the enterprise.

Despite improving maturity overall, many organizations lack

an understanding of the wide spectrum of value that FDA

can deliver — and few are fully realizing the potential of their

FDA deployments, particularly around the cost savings and

efficiencies gained from the use of FDA.

► Use advanced technology

In almost every circumstance, those companies using

more sophisticated analytics, beyond basic spreadsheet-

type, rules-driven tests, report better fraud detection in

less time. These successful FDA deployments are

harnessing sophisticated analytics tools, including social

media and web monitoring, voice searching and analysis,

and visualization and reporting tools.

► Analyze more data

We have observed a positive correlation between the use

of large data volumes (over 10 million records) and

achieving positive results of FDA implementation. The

same is relevant to data variety, with those reporting

positive results also applying a much broader array of

both structured and unstructured data sources.

► Invest more of their total compliance and anti-fraud

spend in FDA


Our survey found those reporting positive results invest one-

third of their total anti-fraud program budget on FDA.

Around the world, many leading organizations are

harnessing the full benefits of FDA, but others are struggling

to do so.

Boards and senior-level management who see FDA's

potential, but have yet to come to terms with the investment

required, need to understand the broad range of value that

sophisticated analytics can deliver. Once this is appreciated,

the business case for FDA becomes clear

Case study: Third-party risks – Vendor

Supplier ABC mainly provided maintenance services of

counters in department stores to a cosmetics and beauty

group. EY conducted FDA during the annual supplier audit,

and observed that purchase orders (“POs”) were placed

highly frequently but in relatively low PO value. Besides,

several groups of POs were identified as potential split POs.

Based on preliminary review on PO supporting

documentations, certain pricings appeared to be

inconsistent and unreasonable. EY then thoroughly

reviewed all the POs placed with this supplier, and confirmed

the observations noted through FDA – several groups of POs

were split to avoid high level approvals. Additional red-flags

were also identified, such as non-compliant labor

employment and potential overcharges on certain items.

Disciplinary action was carried out to Supplier ABC, and the

relationship was terminated afterwards.

3. Frequent compliance audit

It is crucial not only to conduct due diligence when entering

into new business relationships but also to have a robust

compliance auditing system to monitor activities. A robust

performance contract needs to be in place that requires the

third party to:

► Comply with the relevant national and local laws and

regulations

► Comply with the company's ethical policies

► Agree to regular audits or reviews

Having audit provisions in the contract is not enough,

companies must conduct on-site compliance audits in a

timely manner.

These measures demonstrate to third parties the importance

of ethical business conduct. Third parties should be aware

that they need to maintain full and transparent information

of all business dealings (including expenses incurred) on

behalf of the company, making them available for review

when required.

Our prior experience indicated that when conducting on-site

compliance audits, the challenges may include the following

and our suggestions are:

► challenges may include the following and our suggestions

are:

► The existence and extent of the right to audit clause in

the contract: The clause should be comprehensive

enough to include the extent of the compliance audit that

will be undertaken (e.g., not purely a financial review, but

also an understanding of the compliance framework).

► Sophistication of the third party’s financial systems : It is

very common for a third party to have only one financial

system and lack of segregation between its records

relating to its different customers. As a result, reliance

on the information provided by the third party would be

limited as it cannot be verified independently. One way

companies can get around this is by putting a clause in

contracts requiring the third party to segregate its books

and records relating to the specific company.

► Frequently, third parties raise confidentiality concerns

around providing documentation as they also work with

other business parties. As a result, these reviews are

usually conducted by a team of external consultants with

experience in this field.

In addition, there must be an incentivization of compliance

or a threat of disengagement for non-compliance. Standards

must be applied vigorously to these third parties because of

their importance to the company’s performance, and not just

for fear that non-compliance could cause issues for the

company. Accountability is an important aspect of any

business relationship.


How prepared are you?

1. Does your company have a rigorous third-party integrity

diligence procedure to assess new business relationships?

► Meeting local and international regulations

► Requiring third parties to comply with your anti-bribery

and anti-corruption (ABAC) policies and authorized to

conduct regular audit and review

► Having complete transparency in the way that the third

party is remunerated; not just fees or commissions, but

also expenses

2. Are you conducting integrity diligence for all third-party

relationships?

► Developing risk profiles to assure high-risk third parties

are more rigorously reviewed


3. Does your company have an on-going monitoring

framework for all third-party relationships?

► Using FDA to access 100% of the available and relevant

data to assess performance and detect misconducts

4. Are compliance audits conducted on a regular basis and

in a timely manner?

► Auditing all relevant business dealings conducted by the

third party, as well as the beneficial ownership of the

third party and its reputation

China Individual Income

Tax: Key industry insights

Freeman Bu

Partner, People Advisory Services

[email protected]

Crystal Zhang

Director, People Advisory Services

[email protected]

Lucia Zheng

Manager, People Advisory Services

[email protected]

In the past few years, stock incentive plans

have become a popular tool for companies

to retain talent and compensate employees

in the long-run. Plans of stock options,

restricted stocks, stock appreciation rights,

are commonly adopted by Consumer

Products and Retail (CPR) companies.

From China Individual Income Tax (IIT)

perspective, favorable tax policies for stock

incentive plans have been issued and they

have started to attract considerable

attention from the business community to

further encourage entrepreneurship and

innovations.


In the meantime, relevant guidelines have been issued by the

State Administration of Foreign Exchange (SAFE) to solve

the foreign exchange issue of stock incentive plans

implemented by overseas listed companies that cover

Chinese employees of Chinese subsidiaries.

CPR companies in China are fighting for growth in an

increasingly digital society that is being transformed by

macroeconomic megatrends, mobility of capital and growth

in technology. Based on our observation, CPR companies in

China are increasingly using stock incentive plans to retain

and compensate key talent and management employees. In

this article, we would like to highlight the favorable tax

treatments available and steps companies need to take to

comply with regulatory requirements.

1. Favorable tax treatments for stock incentive plans of listed companies

Normally stock incentive income is taxed as regular

employment income at the marginal rates ranging from 3%

to 45%. Such income derived from the stock inventive

awards will be aggregated with regular monthly

employment income and subject to the above marginal IIT

rates.

However, a favorable IIT calculation method can be applied

to the gain arising from exercise of stock options/stock

appreciation rights or vesting of restricted stocks provided

that the following conditions described in Tax Circulars 35,

461 and 27 are satisfied.

a) The individuals are employees of publicly listed companies

(including branches) and their subsidiaries.

b) Equity-based award is derived from plans that are

implemented by the listed companies.

c) The subsidiaries should be at least 30% owned by the

listed companies.

d) A tax registration for the stock incentive plans is

completed by the companies with local tax authorities.

Under the favorable IIT calculation method, the gain (or

income) can be divided by the relevant vesting months

(capped at 12), and each quotient will be taxed as a monthly

salary. Obviously this method will normally result in a lower

applicable tax rate and will lower the tax liability on the total

gain.

In addition, for any new grant, exercise of options/stock

appreciation rights or vests of restricted stock under the

plans, relevant information should be submitted to the local

tax authorities for records.

2. Favorable tax treatments for stock incentive plans by private companies

In late 2016, the Ministry of Finance (MOF) and the State

Administration of Taxation (SAT) jointly issued Caishui

[2016] No.101 (Circular 101), which provided favorable tax

treatments to stock incentive plans implemented by private

companies. Under Circular 101, an employee can defer IIT

payment until the stock is transferred while in the past IIT

should be paid when gain is “realized”. For example, when

stock options are exercised by an employee, the employee

buys stocks at a discount and owns the stocks, he or she

should pay IIT on the gain (discount) even he or she has not

yet sold or transferred the stocks. In addition, instead of

being treated as “salary” and taxed at IIT rates up to 45%

previously, the gain will now be treated as "income from

transfer of property" and taxed at a flat rate of 20%. This is

very preferential especially when the gain is significant.

The following criteria must be met for employees to be

eligible for the favorable tax treatment and IIT deferral

based on Circular 101:

► The equity incentive plan is implemented by a domestic

resident enterprise and the underlying equity should be

the equity of a domestic resident enterprise.

► The equity incentive plan is approved by the board of

directors or the shareholders' meeting.

► For technology contributions, the underlying equity can

be the equity acquired from investment with technologies

into other domestic resident enterprises.

► The equity incentives should only be granted to senior

management and core technical staff as decided by the

board or shareholders meeting and the total number of

participants shall not exceed 30% of the average number

of the existing employees of the company in the last six

months.

► Stock options, should be held for at least three years

from grant to exercise and for at least one year from

exercise to transfer;

► Restricted stocks should be held for at least three years

from grant to vest and for at least one year from vest to

transfer;

► Equity awards should be held for at least three years

from grant to transfer.

► For stock options, the period from grant date to exercise

date shall not exceed 10 years.

Again, to enjoy the favorable tax treatment, the tax

registration for the plans should be completed.


3. SAFE requirements for stock incentive plans implemented by foreign listed companies

When a multinational company listed outside of China

implements a stock incentive plan and the plan also covers

local Chinese employees of a Chinese subsidiary of the

multinational company, a SAFE registration should be

performed by the Chinese subsidiary. The Chinese

subsidiary can then legally open a special bank account

through which Chinese employees can remit funds outside

China to purchase shares and receive funds from overseas

arising from sale of stocks, under the stock incentive plan.

Under the current Chinese regulations, Chinese citizens are

restricted from investing in shares of foreign companies.

The Chinese subsidiary should provide details of transactions

in this bank account to the local SAFE office for review and

records.

4. Areas CPR companies should be aware of

In order to comply with Chinese regulations and enjoy

relevant favorable tax treatments, CPR companies listed in

China should review whether they meet the conditions for

the favorable tax treatments and whether they have

completed the tax registration for the stock incentive plans.

Non-listed CPR companies should also review whether they

meet the criteria for the favorable tax treatments and

whether they have performed the tax registration. When

they have not but intend to implement stock incentive plans,

they should carefully design the plans so that the criteria can

be met and the favorable tax treatments will be available to

employees.

For Chinese subsidiaries of multinational companies whose

Chinese employees are covered by stock incentive plans of

overseas listed companies, they should review whether the

SAFE registration has been performed properly.

Where necessary, CPR companies should seek professional

advice on the above tax and SAFE matters. To discuss how

we can support your business, please contact your EY

advisor.

The views reflected in this article are the views of the author

and do not necessarily reflect the views of the global EY

organization or its member firms.


EY | Assurance | Tax | Transactions | Advisory

About EY

EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

© 2017 Ernst & Young (China) Advisory LimitedAll Rights Reserved.

APAC no. 03004780ED None.

This material has been prepared for general informational purposes only

and is not intended to be relied upon as accounting, tax, or other

professional advice. Please refer to your advisors for specific advice.

ey.com/china

Follow us on WeChatScan the QR code and stay up to date with the latest EY news.

Contact us

Eric Chia

Partner

Advisory Services

+ 86 21 2228 3388

[email protected]

Alfred Yin

Partner

Assurance Services

+ 86 21 2228 2152

[email protected]

Arnold Sun

Partner

Transaction Services

+ 86 21 2228 5235

[email protected]

Audrie Xia

Partner

Tax Services

+ 86 21 2228 2886

[email protected]

Date post:	23-Jun-2020
Category:	Documents
Upload:	others
View:	7 times
Download:	0 times

EY Greater China Consumer Products and Retail Sector...

Documents