China’s New Tax Incentives

June 18, 2008 Posted by China Briefing Reading Time: 5 minutes

June 18 – With the unification of China’s tax base at the beginning of 2008 to 25 percent (as predicted by China Briefing in April 2006, see page ten of the issue) much of China’s previous tax incentives for attracting foreign investment into the country dried up. Gone were the wholesale 15 percent uniform tax rates for manufacturing enterprises, gone too were the attractive five year tax breaks of two years zero and three years 50 percent of the applicable rate. Yet, as we noted yesterday, foreign investment hasn’t slowed down at all, the country remains an attractive destination for foreign investment. There are three main reasons for this.

WTO admission
China has, in accordance with the WTO requirements, opened up its markets to foreign investment and participation. Although there are still areas of resistance in some of the inland regions to foreign participation in long-protected local industries, in time this will change. Strategic industries, as is common elsewhere, will remain restricted in line with the Communist Party’s areas of concern, but generally speaking, the WTO aspect has been good for China and good for foreign investors.

Stability and infrastructure for export manufacturing
Despite the odd regional hiccups, the export manufacturing aspect of China, largely based along its southern and eastern Coasts, remains excellent in terms of infrastructure, cost of labor (although regional differences away from Shanghai and parts of Guangdong are moving this northwards) and the availability of semi-skilled and skilled labor. Quality control issues are improving, and China strategically is well positioned to take advantage of developing regional markets. Although the cost of fuel may dampen some longer-routed exports such as to the United States, generally the outlook is very positive.

Growing consumer-driven middle class
The Chinese are progressively having more money to spend, and international brands are still considered superior. That wealth is developing also, an estimated 250 million Chinese now are able to purchase property and a car. That massive spending power is a major driver for setting up in China and selling to the China market.

Under such circumstances then, given that the China tax base is reasonable, China doesn’t really now need to offer wholesale tax incentives as it has done in the past. Therefore, nationally implemented tax incentives are from now not going to impact on the tax base per se, but be made available through discounts, or occasional rebates. However, these will be far more selective than previously available, and will be arranged as commercial transactions rather opposed to pure tax holidays.

Rental and purchase discounts on state-owned property
Although not new, these will be increasingly driven by both the central and regional governments’ desire to drive investment into specific areas. A case in point is Beijing’s new Financial Street area. Desirous of getting prestigious foreign banking institutions into the area, significant rent rebates were agreed as part of a package for banks taking a certain space size within the district, over a certain period of time. Some of these arrangements, according to a senior Swiss investment banker we spoke too, were worth millions of dollars and were enough to persuade the bank of the financial attractiveness to relocate. The bank concerned now employs 250 staff in its back office operations in Beijing, as opposed to 150 in Shanghai.

This policy of using government-owned property to provide incentives to investors is likely to increase – it neatly sidesteps the national tax regulations as it is a commercial transaction, not a tax based incentive. “We don’t mind how the incentive reaches us,” was the comment, “as long as it is there.” Big ticket investors will now require closer relations with property agents to inquire as to which government property has the most attractive contractual rebate clauses.

Discounted property investments against individual income tax thresholds being met
In order to attract more high level international businessmen to China, local governments are also offering a re-investment scheme if a foreign individual reaches a certain level of declared individual income tax. This can include discounts on the purchase of local housing, and even for vehicle purchasing. Some of these, dependent upon the target property, could be significant. Again, it’s not a manipulation of the tax base, but more a compliment on achieving a certain tax payer status in China. It’s a clever scheme, and one which we are likely to see more of.

Such schemes herald a new approach to assessing incentives in China. Rather than being tax driven, they are more subtle, and are being linked to the quality of the investment, rather than any nationally driven policy affecting everyone. Businesses looking to invest in China now will need to look more deeply as to what local governments are prepared to provide, and assess the need for taking advantage of them is really there or not.

Encouraged industries
The central government has indicated the availability of tax incentives in certain industries, high-tech being one example. However, China employs a two-stage mechanism to introduce these, announcement of the incentive, and later, the implementation rules. Inexperienced overseas lawyers caught in this tend to hate it as they cannot advise clients with 100 percent accuracy. However, as we have seen, once China announces tax incentives—even without the implementing rules—they will still provide the incentive, even if for technical reasons there may be a delay in getting it signed off. The rule to observe when the government announces tax incentives without implementation rules is to go for them anyway. The Chinese government will catch up with the formalities later. Also, China-based lawyers and tax advisors with a decent presence in Beijing should be able to advise clients on the likely scenario, even without an implementation rule safety net. In 16 years in China, we have never seen the government backtrack on statements made over tax incentive intentions, despite the lack of the implementation rules.

Western and central regions investment incentives
This has been hinted at over the years, but nothing concrete has ever been released. We doubt they will be, although it does remain a possibility. Investment incentives in the Central and Western China will be instigated regionally, rather than a centrally managed, and may well concentrate as we have seen above, on specific incentives to particular areas or zones. Some of these regions, especially in the west, have sensitive border areas. Others contain strategic military or government research installations. It makes sense then to assume that investment incentives in Central and Western China will develop as local incentives, again based on property and actual investment value, rather than a specific investment policy for the regions. International investors looking at expanding into these areas of China will need to acquire access to good local on-the-ground knowledge to assess the quality of incentives on offer.

Dezan Shira & Associates is a premier boutique professional services firm in China providing legal and tax advice to foreign investors in the country. Established in China 16 years ago, they maintain nine China offices. This website and the China Briefing Magazine are produced by the firm. For advice on foreign investment legal and tax issues in China, please email info@dezshira.com or visit www.dezshira.com.