Small-business owners with an eye on expansion should take a serious look at China.

Sure, the headaches are many and road maps are scarce, but with China's unprecedented growth, small businesses in the U.S. risk falling behind the competition if they don't learn to sidestep the hurdles and head East.

By the end of the year, China will stand as the third-largest market for U.S.-made products, up from only sixth-largest in 2002. "China might be the last frontier for a U.S. privately held company to become bigger," says Alexander Pan, CPA and tax partner in the China Business Group of PricewaterhouseCoopers.

China's growing middle class, low labor costs (by 2010 manufacturing labor costs are still expected to be more than 10 times lower than in the U.S.), crumbling regulatory barriers and entry into the World Trade Organization have made it an attractive country for private companies that are seeking to expand. According to PwC's Private Company Services paper on establishing a business presence in China, 62% of companies surveyed by the American chamber of commerce in China in 2005 reported that their number one business goal was to produce goods and services in China for the domestic market.

Unlike Fortune 500 companies, the owner of a private company doubles as decision maker, a trait that allows such companies to move quickly and flexibly in China's fast-growing economy. Over the past 10 years, Pan has seen small importers expanding from a million dollars in sales to a half billion.

"China is still in the tradition of distribution," says Pan. "The U.S. market won't provide that fast of a growth opportunity." Among 610,000 businesses in China, he points out, 50,000 are U.S. companies, the majority of which are not publicly traded.

But before packing the covered wagon and heading overseas in search of growth gold, U.S. privately held companies need to be aware that the climate in China's rapidly expanding economy can be as wild as the old West. The idea is to know your new terrain.

Taxes Made Complicated

The Unified Enterprise Income Tax Law, enacted in March 2007 and taking effect in 2008, standardized the tax treatment of domestic and foreign invested enterprises in China. But, here, standardization is an exception to the rule.

China's unique system of income tax, custom duty regulation and value added tax (VAT) is difficult to navigate. Mismanagement of these tax systems can increase the cost of operations by 10% to 17%.

But luckily, change is moving quickly in China, says Pan, and like the income tax, the government is leaning toward unification of the three tax systems. For now, a private company should seek advice from experts or local professionals. Since different governmental departments use different measurements for each type of tax, keep separate accounting records to track each.

Locales Divided

In addition to the tax hurdle, local law systems and enforcement agencies differently interpret how regulations should be applied. Even a private company that's established in one locale must seek advice when moving to another city, says Pan.

"You have to have someone familiar with the system to guide you before you realize what the rules and regulations are on many issues," says PwC partner Michael Ho. Local governments, he says, often lack transparency on different policies. While giants like Nike ( NKE) and Microsoft ( MSFT ) can rely upon consultants and lawyers, the humble private company should tap into a Chinese partner already familiar with local laws, says Ho.

Still, a private company might be taken advantage of by a more culturally savvy business partner, so do as much of your own homework as possible. "It's hard to be completely in compliance in China," says Pan.

Export Alerts

Over the past four months, China imposed several new regulations that discouraged the export of certain products to the U.S., including certain materials that may contain hazardous substances. U.S. importers should be aware of the new regulations and should make sure their products and materials are up to U.S. standards for import, says Pan.

Also, be aware of the VAT, which is imposed on each cycle of the manufacturing and selling process in China. When the product crosses borders, the VAT can't go with it, so in theory the Chinese government gives a VAT refund to importers. In practice, the refund is usually partial. U.S. importers should be aware of this duty and structure their businesses accordingly, says Ho.

Despite frustrating tax laws and infrastructure and concerns that China's economy may be overheated, the Chinese economy as a whole has maintained over 9% average GDP for the past 28 years and over 10% for the past four years, Pan points out. Because of its fast-growing middle class and a service sector that grows more than 12% per year, Pan predicts China's momentum will persist.