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A Stew Pot of Asian Taxation and Economic Stimulus

By Laurence E. Lipsher - Email Editor

Date : September 10, 2009

Dear Valued Reader,

Summer in Guangzhou is hot and humid. On the day I’m writing this, it’s going to be 35 degrees Celsius (95 degrees Fahrenheit) — hotter than any of the other cities whose temperatures I monitor daily on my iPhone. Decades ago, I was told that within only a few years of living here, I’d stop sweating. That was a lie. Asia is where I measure my summer days by how many times I have to change my shirt when I spend time outside in this hot, bubbling stew pot.

China

It’s official: There will be no ‘‘special curb’’ restricting foreign capital from entering China’s real estate sector, according to Sun Peng, deputy director of the foreign investment management department of the Ministry of Commerce, as reported in the China Daily. I both agree and disagree with the Chinese government regarding real estate foreign direct investment. Yes, FDI is needed, but why doesn’t the government impose location restrictions? It should direct monies away from the overbuilt, first-tier cities of China and offer incentives instead, not only toward development in the third-, fourth-, and fifth-tier cities, but also for the development of affordable housing, which is far more important for economic recovery than luxury housing.

China is concerned that foreign direct investment, year on year, has dropped 17.9 percent, and it needs the investment to keep the economy running positively. The Chinese have an escape valve for their money — they invest in Hong Kong real estate. There are prohibitions against this, but it is so easy for the Chinese to work around them: For just a bit more than they’re planning on spending in Hong Kong, they first ‘‘buy’’ a residence permit from the Philippines (a great source of tax revenue), thereby qualifying them to purchase at Hong Kong prices, which have not dropped. Hong Kong’s citizenry have not purchased what I consider to be overpriced real estate. Perhaps now those Hong Kongers will take their funds and plow them back into Chinese real estate, thereby employing the migrant workers who fund the rural economy when there is construction work for them.

The State Administration of Taxation (SAT) announced on August 2 that corporate taxes collected from ‘‘noncitizen’’ firms in China rose 40.7 percent, year on year, to CNY $22.2 billion. Noncitizen companies in China are not the same as foreign-funded firms. These are entities established outside China that have invested in China without setting up actual Chinese business operations. This is interesting because, simultaneously with this year-on-year increase, corporate income tax revenues from entities in China dropped 13.8 percent.

Preferential tax policies for noncitizen firms ended last year, with the introduction of the new enterprise tax laws that targeted revenues from dividends, bonuses, and asset transfer earnings. The SAT asked Chinese firms to collect, on its behalf, a 10 percent tax when paying annual dividends to noncitizen firms. Dividends now, capital gains next? The overwhelming majority of collections in this area came from the Jiangsu and Guangdong provinces, Beijing, Tianjin, and Shanghai.

While the SAT and Ministry of Finance jointly issued three sets of tax rulings at the end of April, interpretations of these rulings are finally coming out during the heat of summer. Domestic corporate restructuring can be performed tax free, provided conditions imposed for ‘‘special tax treatment’’ are satisfied. While these special treatment rulings are now available, I seriously wonder the degree to which local offices of the SAT are familiar with them. I say this because one of the other April 30 rulings, Circular 60 (Caishui [2009] No. 60), dealt with tax liabilities arising as a result of liquidation of a Chinese company. I am sensitive to this situation, having liquidated/ dissolved my Chinese entity in December 2008. While we did wind up paying a liquidation tax, I must say that it was reasonable — of course, this, too, was part of the overall negotiation process involved with the liquidation.

While all of this has been going on, the Financial Times reported on August 1 that China’s official Purchasing Managers’ Index increased from 53.2 in June to 53.3 in July. This is the fifth straight month that the official Purchasing Managers’ Index has stayed above 50, the point below which means economic contraction instead of development. Of the 20 industries covered within this survey, 14 reported growth in new orders. Growth compared to when?

‘‘These figures reflected that mainland manufacturers continued to benefit from strong domestic demand and an improving export situation,’’ a spokesperson for Li & Fung, a leading Hong Kong trading group, said in an accompanying research note attached to the report.

And yet, according to the leading headline in the August 4 issue of the Financial Times, the latest set of first-half numbers provided by provincial-level authorities are far higher than the central government’s national figure, raising questions once again about the reliability of Chinese statistics. With the world looking in admiration (and jealousy) at China’s economic recovery, the statistical discrepancies are yet another reminder of the unreliability of statistical data coming out of China and how this information, more often than not, is manipulated regularly by officials for personal and political purposes. This hasn’t changed in 50 years.

And how does the man in the street feel about the growth information being issued by the National Bureau of Statistics? The Global Times, controlled by the People’s Daily, reported that the public reacted with ‘‘banter and sarcasm’’ to the bureau’s figures showing that average urban wages in China rose 13 percent in the first half of 2009 to CNY 14,638 ($2,142).

As long as the urban population is making enough money to be content and optimistic, the central government has little to worry about. If there is urban discontent, there will be some really big problems. Yahoo News on August 3 posted a photo of prostitutes at a brothel in Shanghai, along with this interesting bit of news: ‘‘Prostitutes are considered more trustworthy in China than government officials and scientists, a recent survey of more than 3,000 respondents showed.’’ While I am not quite sure how trustworthy a Shanghai prostitute is (and if I did know, I’m not about to admit it, living at home with a Chinese wife who possesses a rather sharp meat cleaver), I do know that the central government does have a problem on its hands when its bureaucrats are victims of public cynicism.

South Korea

In early August there was a wealth of media reports about the ‘‘surging,’’ rebounding Korean economy. The writers of those articles are in denial — South Korea is not on the economic rebound, and things are really not coming up roses in the land of delightful food and well-played team baseball.

The National Statistics Office (NSO) proudly announced that its composite leading indicator rose 2.8 percentage points to 120.8 percent from May, the quickest gain since the NSO started compiling these data in 1970. The composite leading indicator has been rising for the past three months. ‘‘These figures represent a strong recovery trend in the economy,’’ said Yun Myung-joon, director at the NSO.

Lone Star, the U.S. buyout fund that invested so heavily in Korea, finally seems to have gotten a favorable ruling.

And yet the Financial Times recently printed a Reuters report indicating that exports for July slid an additional 20.1 percentage points from a year ago as reported by the Ministry of Knowledge Economy (don’t you just love that name?), after a 12.4 percentage point fall in June. Sales to China, the country’s biggest foreign market, fell 15.7 percentage points for the first 20 days of July. Exports to the U.S. for that same 20-day period fell by 26.5 percentage points. True, Korean imports during this same period also fell by 35.8 percentage points, year on year, causing a trade surplus, but a trade surplus of this nature is definitely not indicative of economic recovery. The Central Bank shows no indication of increasing, at least through the end of 2009, what are already the lowest interest rates on record.

Enough said about the economy that I consider to be in the worst shape of any of the nine jurisdictions I cover. Let’s look at some recent tax activity in Korea.

Remember Lone Star, the U.S. buyout fund that has invested so heavily in xenophobic Korea? (For prior coverage, see Tax Notes Int’l, Sept. 15, 2008, p. 927, Doc 2008-17508, or 2008 WTD 183-8.) Well, all I’ve been able to report about it in the past is that it’s been given the shaft, time and time again. It finally seems to have gotten a favorable ruling!

The Korea Herald reported August 3 that the Seoul High Court ruled in favor of Lone Star against the Seoul Municipality, which tried to impose KRW 25.3 billion ($20.6 million) of registration taxes and penalties on Lone Star because of its purchase of Gangnam Financial Center. In 2001 Lone Star bought the Gangnam center, which had been vacant for years, and paid the appropriate registration taxes. The Seoul Municipality imposed an additional KRW 25.3 billion, claiming that the Lone Star buyout was, in effect, the inception of a new corporation. The court, in announcing one of those rare verdicts in favor of a non-Korean entity, stated: ‘‘Taking the assets of a dormant corporation and changing their original purposes may not be seen as founding a new company. The city’s tax imposition on such premises should be cancelled.’’ I wonder if the city will appeal this decision to the national court, and what that decision will be.

The only other interesting tax matter is the government’s proposal to reduce the capital gains tax on real property, which ranges between 45 percent and 60 percent (so much for taxation as an incentive to develop real estate), to amounts that actually are starting to sound like incentives: between 6 percent to 35 percent. Also, entities selling real property to repay existing debts will get a maximum postponement of repayment of up to three years. What happens if that company, selling its real estate, postponing its tax payments, goes belly up during the postponement period? Will anyone be held responsible for eventually paying off those taxes? I will write more about this if and when this proposal becomes reality.

Other Developments

Korea and India

After three years of negotiations that started in March 2006, Korea and India signed their version of a double tax avoidance agreement in Seoul on August 7, according to a report in The Korea Herald.

This agreement, being called a ‘‘comprehensive economic partnership agreement,’’ is the second one Korea has entered into recently; the first was with the European Union. This is Korea’s first foray into any sort of agreement (according to the Herald) with any of the BRIC countries (Brazil, Russia, India, and China). It will cover trade in goods, services, and investments. It also contains chapters on competition and intellectual property rights.

Tariffs on goods are expected to be phased out over five to eight years — after the agreement is ratified by the legislatures of both countries. This is expected to take at least a year, most likely two years. Tariffs for auto parts, which average 12.5 percent, are likely to be eliminated over the maximum eight-year period. Of course, by that time India is likely to have built up its own automobile parts manufacturing industry, thereby making this treaty not really worth much more than the paper it’s written on.

The Korean government has stated that while the tariff removal rate is slower compared with most other double tax avoidance agreements, Korea has the benefit of having secured a foothold in the market ahead of either China or Japan. The Korean Trade Ministry spokesperson who made that statement is sadly misinformed.

China and Pakistan

I will bet you didn’t know that there is a China- Pakistan Economic Zone in Kala Shah Kako, near Lahore. I didn’t know either until I read an August 4 article on Asia Times Online.

The zone, established through the free trade agreement signed by the two countries in 2006, is intended to comprise an industrial park, a science and technology park, supply chain industry, a skill development center, and a research and development center. China will train Pakistani workers, sell consumer household items and textiles, purchase raw materials from Pakistan, as well as use Pakistani ports and take advantage of lower freight rates for China’s rapidly developing African trade. This will be a tariff-free area (unlike under the India-Korea deal), and there will be Pakistan tax benefits for Pakistan.

A memorandum of understanding has also been signed between Ruba General Trading Company of Pakistan and China’s Haier Group. Haier is initially investing US $35 million and bringing along approximately two dozen additional Chinese companies to this zone, which will be used exclusively by Chinese investors and China-Pakistan joint ventures.

Hong Kong and Vietnam

The Radio Voice of Vietnam recently announced that the Hong Kong-Vietnam double tax avoidance agreement signed on December 16, 2008, will take effect January 1, 2010. (For the treaty, see Doc 2008-26437 or 2008 WTD 243-20.) This should be of particular interest to any Hong Kong manufacturers who might be in a financial position to start an export-oriented business, once an economic upturn opens up the export market. If the Pearl River Delta does not want any more labor-intensive polluting industries and those manufacturers do not want to move further inland, Vietnam would once again present an interesting alternative for start-up business.

Until next time,

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