Professional Documents
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This article is the continuation of my last article on Strategic Analysis of citizens in a country, inflation, taxation rate and conditions within
which focused on the models, theories and concepts used for analysing an industry which all affect an organisation in one way or another. For
purposes and expectations of the strategic analysis stage in strategic example, Starbucks has recently announced its closure of 600 outlets in
management. In this article, I will discuss on the models, theories and the US and slowing down on its expansion plan. This is largely attributed
concepts for ‘external analysis’. to the recession in the US, and thus has caused the US citizens not being
able to spend on buying luxury goods.
External analysis – Macro environment Social factors such as demographic factors (population trends)
Macro environment is the general environment of an organisation. It like birth rate and aging population have significant impact on an
is also the market (or country) environment of an organisation. It can be organisation’s strategy. In many Asian countries, aging population has
analysed by using the PESTEL framework and Porter’s Diamond. reduced the sales of an organisation producing infant products but it
also has brought opportunities for an organisation to sell new products,
PESTEL for example, insurance companies start launching insurance policies to
PESTEL stands for the Political, Economical, Social, Technological, senior citizens. In addition, cultural factors and social trends will also
Environmental and Legal factors. An organisation will need to identify influence an organisation. For instance, increase in health consciousness
the PESTEL factors which influence its strategies and operations, and has resulted in increased demand for organic food and vegetarian
how these factors change over time. restaurants in Asian countries.
Political factors include Inter-country relationship, political stability, Technological changes have altered the way organisations operate.
government policy on foreign direct investment, terrorist activities, trade Advancement in telecommunication and Internet technologies have
barriers and taxation policy. When a government changes its policy, an enabled firms to sell their products and offer their services online. For
organisation may be given more opportunities or may face more threats. example, Tesco allows its customers to shop online. Technologies have
For instance, agreement made between China and Taiwan to allow direct become a threat to many businesses too. For organisation like Sony,
flights between certain destinations of China and Taiwan has created Intel, Nokia and Creative who operate within the high-tech industries,
business opportunities for air carrier operators, hotel and resort operators, technological changes allow their competitors to create new products to
travel agencies as well as restaurant operators. replace theirs. This not only intensifies competition within the industries,
Economical factors include general country economy, income level these companies also ‘retaliate’ by investing enormously in their research
Firm strategy,
structure and Threat of
rivalry Threat of customers’ Threat of suppliers’
competitive
bargaining power bargaining power
rivalry
Figure-1: Porters Diamond
The first factor is the factor conditions which are the resources
required for developing an industry. These resources include physical
resources like lands and materials as well as human resources including Threat of substitutes
skills, knowledge and experience needed to build the industry. Germany
is very successful for its automobile industry because it has outstanding
engineers and technologies for manufacturing cars with top quality. Figure-2: Porter’s Five Forces
The second factor is demand condition, meaning local demand for
products and services as well as expectation of local customers. There Threat of new entrant - This is the threat of new competitors; the
must be a strong demand in the home market (the country itself) for the strength of this threat depends on existence of barriers to entry (e.g.
industry’s products and services. specialist skills required, brand and customer loyalty) and action of
This factor determines how an industry responds to customers’ needs existing competitor. When the barriers to entry are high, the threat of
and thus has the thrust to innovate. For instance, demanding Japanese new entrant will be low.
customers have high expectations on electrical and electronic products Threat of substitutes - This is the threat from replacement of an
which in turn have provided the driving force for electrical and electronic organisation’s product for example budgeted airline is the substitute of
industries in Japan to blossom, and Japan becoming the leading country bus and train. Strength of this force depends on the quality and price of
of such products in the global market. When domestic customer is not the substitute and the switching cost. When the substitute product price
demanding, it does not force the industry to innovate to be excellent. is low and its quality is equivalent to our product, the threat of substitute
The third factor is related and supporting industries. The success will be very strong. Low switching cost will also increase this threat.
of an industry is linked to its related industries. For example successful Threat of supplier’s bargaining power - This will be pressure that
supplier exerts on an organisation. The strength of this threat generally falling. There is a tendency for companies to merge, which helps in cost
depends on the company size of the supplier, availability of substitutes reduction and puts up barriers to entry of new entrants because they
and customer’s volume of purchase. Generally when the customers would be too small to compete. Some companies will drop out of market
have more choices of suppliers and substitutes, the threat of supplier’s altogether.
bargaining power becomes weak. In the decline stage, competitors will exit from the industry or market
Threat of customer’s bargaining power - This will be pressure and price war may take place as firms are fighting for market share in
that customer exerts on an organisation. The strength of this threat is a declining market and at this stage competition level is the highest.
similar to threat of supplier’s bargaining power, generally depends on the Pressure from substitutes intensifies thus threat of substitutes is high.
purchase volume of the customer, availability of substitutes and switching
cost. When a customer has a few choices of suppliers and substitute SUMMARY
and / or switching cost is high, the customer’s bargaining power will be In this article we have discussed main models, concepts and theories
reduced. used to carry out strategic analysis stage in strategic management, we
Threat of competitive rivalry - This is the threat of the competition can summarise them with the following table.
among existing competitors within an industry. The strength of this
force depends on number of competitors in the industry, demand and
supply condition in the industry, availability of substitute and switching Area of analysis Models, concepts and theories used
cost. More competitors and substitutes in an industry will intensify the
competition in the industry.
Macro environment (market) PESTEL and Porter’s diamond
When the threats of the five forces are strong, the competition within
an industry will be more intensified and the less attractive the industry
will be. Micro environment Porter’s five forces analysis and
(industry/sector) Product life cycle
Life Cycle Analysis
Every market and industry have different life cycle, at different stages,
the competitive forces and critical success factors will change. Generally Reference: Exploring Corporate Strategy (7th Edition) by Johnson G,
competition becomes more and more intensified through the life cycle of Scholes K and Whittington R, Prentice Hall (2005).
an industry (or market). It is advisable to enter a market or industry that
is in the growing stage. The length of the cycle varies from industry to
industry depending on the type of product and technology. For example
life cycle for mobile phone industry is short but long for aircraft industry.
Relevant to Paper P3 & P5 - by Andy Tan
(Lecturer at Accountancy Training Company (Hong Kong and China))
Sales
Competition
Sales
Time
With the introduction of the new Corporate Income Tax Law, Circular place of business in China whose activities are not of a preparatory or
Guoshuihan [2007] No.403 (“Circular 403”), as well as the Second auxiliary character; (ii) a service PE arising from construction, assembly,
Protocol to the Arrangement between China and the Hong Kong Special installation project or provision of services in China; (iii) an agency PE in
Administrative Region (“HK”) for the Avoidance of Double Taxation and China.
the Prevention of Fiscal Evasion with respect to Taxes on Income (“China- Among the aforesaid types of PE, Service PE is traditionally the
HK DTA”), the concept of Permanent Establishment (“PE”) has become focus of Chinese tax authorities as the local tax authorities have diverted
more than a technical risk. In order to mitigate any potential PE risk, interpretations concerning the existence of a Service PE, despite the
many foreign enterprises are re-evaluating and restructuring their business established tax rules.
models in China.
In the context of most tax treaties concluded between China and Service PE
other jurisdictions, three criteria are usually used to ascertain whether the Under most tax treaties concluded between China and other
activities of a foreign enterprise would constitute a PE in China, namely jurisdictions, a Service PE is deemed to be in existence if:
“space” (a fixed place of business), “time” (continuous or aggregate (a) A building site, construction, assembly or installation project or
periods), and “function” (activities of a non–preparatory or non–auxiliary supervisory activities lasts more than 6 months; or
character). In general, there are three common types of PE: - (i) A fixed (b) The furnishing of services, including consultancy services, by a
foreign enterprise, directly or through employees or other personnel are regarded as connected projects; while some consider the projects
engaged by the enterprise for the same or a connected project for performed by different business units of the same company, even if
a period or periods aggregating more than 6 months within any for the same client, are unconnected. In addition, some view that two
12-month period. (“Six Months Threshold”) projects are connected if they form a coherent whole commercially and
geographically based on the facts of the cases.
Six Months Threshold for provision of services Though both the United Nations (“UN”) and Organisation for
The counting of the six months has aroused different views amongst Economic Co-operation and Development (“OECD”) Commentary have
the Chinese Tax authorities. Some tax authorities adopt actual days that not laid down further guidance regarding connected project for provision
employees provide services as the counting unit, while others treat any of services, we may also take reference to the relevant interpretation
day in a month as one month. for building site, construction or installation project in the OECD
To preclude the inconsistency, the State Administration for Taxation Commentary, which states that a building site should be treated as a
(“SAT”) issued Circular 403 in April 2007 to provide further guidelines single unit, even though there are several contracts, as long as it forms
on the Six Months Threshold. Though it was issued to further clarify the a coherent whole commercially and geographically. On the other hand,
China-HK DTA, it is widely treated as a reference for other tax treaties where sub-projects are situated at different localities and are contracted
that China has concluded with other jurisdictions, provided that the for in relation to different projects, they are regarded as unconnected
contents of the relevant articles are the same and no other clarifications projects.
were previously provided.
Circular 403 regards the relevant period from the month in which Absence of person availing services – Indirect utilisation of services
an employee of a Hong Kong enterprise arrived in China for furnishing Another issue about the existence of PE in China is whether it is
services up until the month in which the project was completed and necessary to have the presence of the person availing services in China.
the employee left China. If no service was provided for a period of 30 As illustrated in the graph below, Y. Ltd proposes to make investment
consecutive days, one month can be deducted from the relevant period in a company in China and engages X Ltd (a Hong Kong company) for
in which the services were performed. Under this approach, even the the purpose of carrying out due diligence of the proposed target company.
provision of services in China for a day only within one calendar month The employees of X Ltd regularly interact with Y Ltd and discuss their
might be counted as “one month”. findings and give their commendations as to whether or not to make
On the other hand, as reflected in Departmental Interpretation investment. Employees of X Ltd visit China for 190 days and carry out
& Practice Notes No. 44 (revised), the Hong Kong Inland Revenue the due diligence activities, including checking the records and activities
Department (“IRD”) treated a “month” as 30 days, so a “6-month” period of the target company.
meant 183 days. Hence, the SAT’s interpretation was harsher than the
IRD’s and might expose more Hong Kong service providers to PE risks in
Y Ltd. X Ltd.
China.
In an attempt to resolve such differences, the Second Protocol to the
China-HK DTA was signed on 30 January, 2008. Under the Protocol, Overseas
the term “6-month” is now replaced with “183 days”. For instance, if an
employee of a Hong Kong enterprise provides services in China for 10 China
Employees of X Ltd.
days per month, the PE exposures of the enterprise under Circular 403
and the Protocol are different. Under Circular 403, the relevant period
in case is 12 months, which exceeds the Six Months Threshold and
constitutes PE in China. Under the Protocol, the relevant period is 120 Due Diligence
days, which is less than the stated 183 days and would not give rise to
PE in China as a result. Based on the China-HK DTA, as the employees of X Ltd are actively
The Protocol, however, does not stipulate the transitional treatment of interacting with and advising Y Ltd from China, it is likely that X Ltd
the change in counting periods in the China-HK DTA (i.e. from 6-months has rendered services within China. The fact that the person availing
to 183 days). such services (i.e. Y Ltd) is absent in China is not important and can be
disregarded.
Connected project Provision of services to the head office
Connected project is another not well-defined grey area. Whether or The overseas head office of a foreign enterprise may send its
not two service projects are connected is a question of fact and should be employees to China and these employees may render services from China
judged on a case-by-case basis. to the head office. The issue that arises is whether this situation would
Some Chinese tax authorities adopt the “entity-to-entity’ approach, result in a Service PE.
i.e. the projects performed for the same client by the same company As illustrated in the diagram below, Y. Ltd (a Hong Kong company)
Due Diligence
Possible safeguards
To mitigate any potential PE risk, the following good safeguard
measures are recommended:-
® review their employees’ travel pattern in China;
® second the employees who work extensively on China projects to a
PRC entity;
® monitor the time spent on a project by project basis to ensure that
the foreign company to avoid furnishing services in China through
its employees for the same or connected project for a period or
periods aggregating more than six months (or 183 days) within any
12-month period; and
® state the onshore and offshore activities clearly in contracts, etc.
Conclusion
Tax Residency Though the Chinese tax authority has relaxed the Six Months
Tax Resident Enterprise (“TRE”) is a new concept introduced by the Threshold concerning Service PE by adopting 183 days in the recently
newly promulgated Corporate Income Tax (“CIT”) Law effective on 1 issued Protocol, many related issues, namely connected projects, absence
January 2008. A TRE is an entity incorporated outside China but its “place of person availing services and provision of services to head office, remain
of effective management” is in China. Under Article 3 of the CIT Law, if uncertain. Furthermore, the new TRE concept signifies the Chinese tax
a foreign entity is considered to be a TRE, it will be subject to CIT on its authority is escalating its efforts to consolidate and expand its tax base.
worldwide income. Amid the ever-changing tax environment in China, foreign enterprises
The Detailed Implementation Rules of the CIT Law defines the “place should keep abreast of the latest taxation development, and take relevant
of effective management” as the place where the exercising of the overall precautionary measures.
technical highlights
International ® ISA 540 (Revised and Redrafted) Auditing Accounting Estimates,
International Financial Reporting Standards Including Fair Value Accounting Estimates, and Related Disclosures.
The International Accounting Standards Board (IASB) issued the The standard addresses matters such as the auditor’s evaluation
following amendments: of the effect of estimation uncertainty on risk assessments,
management’s methods for making estimates, the reasonableness of
® Amendments to IAS 32 Financial Instruments: Presentation and assumptions used by management, and the adequacy of disclosures.
IAS 1 Presentation of Financial Statements – Puttable Financial ® ISA 720 (Redrafted) The Auditor’s Responsibility in Relation to Other
Instruments and Obligations Arising on Liquidation. The amendment Information in Documents Containing Audited Financial Statements.
aims to improve the accounting for particular types of financial It requires auditor to read the other information in documents
instruments that have characteristics similar to ordinary shares but at containing audited financial statements and the corresponding
present classified as financial liabilities. auditor’s report, and to respond appropriately when such information
® Amendment to IFRS 2 Share-based Payment. It clarifies that vesting could undermine the credibility of the financial statements.
conditions are service conditions and performance conditions only,
and specifies that all cancellations, whether by the entity or by other These standards will be effective for audits of financial statements for
parties, should receive the same accounting treatment. periods beginning on or after 15 December 2009.
The IAASB will amend the following International Standards on
Both amendments will apply for annual periods beginning on or after Review Engagements (ISREs) to clarify to which engagements each
1 January 2009, with earlier application permitted. respectively is to be applied:
International Standards on Auditing (ISAs) ® ISRE 2400 Engagements to Review Financial Statements; and
The International Auditing and Assurance Standards Board (IAASB) ® ISRE 2410 Review of Interim Financial Information Performed by
released the following International Standards on Auditing (ISAs) the Independent Auditor of the Entity.
® ISA 230 (Redrafted) Audit Documentation. The standard explains ISRE 2410 will be amended to apply to reviews by the entity’s
what is expected of the auditor in fulfilling the requirement to auditor of historical financial information other than interim financial
document compliance with ISAs and provide guidance regarding the information. And ISRE 2400 will then only be restricted to the review of
circumstances in which it is appropriate for the auditor to prepare any historical financial information performed by a practitioner who is not
audit documentation relating to the use of professional judgements. the entity’s auditor.
® ISA 260 (Revised and Redrafted) Communication with Those The International Accounting Education Standards Board (IAESB) has
Charged with Governance. It sets out an overarching framework for released the following International Education Practice Statement (IEPS)
communication with those charged with governance and identifies 3 Practical Experience Requirements – Initial Professional Development
specific matters to be communicated by the auditor, including a for Professional Accountants. The practice statement suggests how
requirement to communicate in writing about auditor independence. IFAC members and associates may meet the requirement for a period of