Email Article Print Article

Asian Tax Review: 60 Years of the P.R.C.

By Laurence E. Lipsher - Email Editor

Date : October 13, 2009

Dear Valued Reader,

The People’s Republic of China celebrated its 60th anniversary as a united nation on October 1. While many things have changed in China over the years, some things have stayed the same — for instance, corruption!

The National Audit Office on September 2 came out with its annual report, a 96-page document that discussed the transgressions of each of the 54 agencies that it reviews. Both the China Daily and the South China Morning Post on September 3 reported that:

• the Ministry of Foreign Affairs ‘‘forgot’’ to return to the central government CNY $132 million in visa and passport fees, and also failed to enter on its balance sheet luxury villas it had purchased over the years;

• the Chinese Academy of Sciences embezzled over CNY $1 million to speculate in the stock market, and it lost all the money; and

• the Ministry of Education ‘‘reappropriated’’ over CNY $3 million from its budget for private purposes having nothing to do with education.

Liu Jiayi, auditor general of the National Audit Office, stated in this annual report to the National People’s Congress that about 30 people involved in 116 cases had been arrested and sentenced, and that another 117 people ‘‘received punishment.’’ Only 30 people arrested? Only 117 more people punished? In a culture of corruption, that, my friends, is peanuts!

From some very good but anonymous sources, I am told that the big loser in this year’s corruption report (presumably that portion not made public) is the Ministry of Commerce. This report, by the way, does not give details on funds collected for the 2008 Sichuan earthquake disaster.

I sum up the futility of combating corruption in China with a quote from a September 3 article in the South China Morning Post: ‘‘Growing sums have come within the reach of officials from rising revenues and the government’s current CNY 4 trillion stimulus plan. Anti-corruption crackdowns have had limited success.’’

Economic Growth

Fifty-two years ago, while in Moscow, Mao Zedong told students, ‘‘Today’s situation is that the east wind prevails over the west wind.’’ As far as the world economy is concerned, if the East is manufacturing, the West has got to be buying, and that is obviously very good for the economic health of the world.

I do not believe the statistics coming out of Beijing; a return to 8 percent GDP growth is not what I see . . . yet. There is economic growth here. That’s a start. Accepting the fact that statistics are not to be relied on and that corruption will never disappear just has to be part of the equation as far as doing business in China is concerned. Corruption (including abuse of inside information) is everywhere; some jurisdictions just do it with a bit more finesse.

Job creation in China is the key to economic recovery. After all, bailing out the banks is not unique here, as it may have been in the United States. China has been bailing out the banks for years, as a result of triangular debt caused by lending to state-owned enterprises that never paid back. Migrant workers are finding jobs, but the jobs are not the same as in the past. Previously, the rural migrants worked in factories geared for export. There’s still export, but certainly not as much. There’s no flexibility because there simply is no choice. If there’s no factory work at higher wages (still quite low by any standard), then there’s plenty of construction work — at lower than previous wages. Better to work than not. If you work, you can support your family and there will be some money to spend. Consumer spending is a necessity if there is to be true economic recovery.

Just look out any city window in China and you can count the increase in cranes over the skyline almost daily. I do think there is a luxury housing bubble and an office building glut. I look out the window in Guangzhou. Is the same building boom happening in the third- and fourth-tier cities in China?

One statistic I do believe is the pool of migrant laborers that has been set by the Chinese government at 150 million. The government stated, according to the September 5 China Daily, that of this 150 million labor force, 20 million are still unemployed. I’m a bit more skeptical about this figure — I think it is higher. A front-page article from the same issue also cited 7.9 percent second-quarter 2009 economic growth and 6.1 percent growth for the first quarter. There’s definitely growth, but I question these amounts as reported by the National Bureau of Statistics. Massive infrastructure construction spending, along with urban residential and office construction, has been the primary cause of growth.

Foreign Direct Investment

On September 7, the banner article in Singapore’s The Business Times discussed China’s relaxation of rules for inbound investment. Quotas under China’s qualified foreign institutional investor program are to be increased from $800 million to $1 billion. The State Administration of Foreign Exchange (SAFE, as in, ‘‘Your money is safe with SAFE’’) also stated that the so-called lockup period for insurance, pension, and open-ended Chinese funds will be reduced from a one year holding period to three months and that the minimum required investment will be reduced from $50 million to $20 million. The overall foreign direct investment (FDI) quota for this category has been set at $30 billion. Because only $15 billion has come into China thus far, there is a lot of room for FDI institutional investment expansion.

What the impact will be because of new U.S. legislation is still open to conjecture. But the U.S. is not the only country in the world wanting to invest in China, and if the hourly fees are high enough, I will even come out of retirement and act as an intermediary, preparing forms that will have to be filed by U.S. investors. I sort of feel like Al Pacino in The Godfather: Part III: ‘‘Just when I thought I was out, they pull me back in!’’ After all, who am I to complain about new IRS rules and regulations when I just possibly might be the only beneficiary in China? If the IRS wants to fund my retirement program, why knock it?

J.P. Morgan will be opening a corporate banking branch in Chengdu, in western China, the Financial Times reported September 9. Chengdu is the capital of Sichuan Province, the most heavily populated of all of China’s provinces. It is a city of 11 million people, where wages and costs of living are a fraction of what they are in Beijing or Shanghai. Unilever, Shell, Toyota, Intel, Nokia, IBM, and Microsoft all have a major presence in Chengdu, one of the second-tier cities of China. There are three cities in China regarded as first tier: Beijing, Shanghai, and Guangzhou.

The second-tier cities of Shenyang, Dalian, Qingdao, and Tianjin are in the north. Nanjing, Suzhou, Ningbo, Hangzhou, Xiamen, Shenzhen, and Zhuhai are the second-tier cities on the east coast. Wuhan, Xian, Chongqing, and Chengdu are the second-tier western cities.

While restrictions have been imposed because of real estate bubble fears, limiting investment in the firsttier cities, the second-tier cities are once again open territory for real estate investment. Now that ‘‘restrictions’’ have been lifted, once again allowing for real estate FDI in the second-tier cities, I’d look ahead at the third- and fourth-tier cities. After all, there are more than 200 cities in China with populations that exceed one million. I’m not greedy — why be in competition with others when you can potentially be an investor monopolizing a market where others have not yet gone?

While it is not official policy, it appears to me that the central government is pushing FDI in Wuhan, Chengdu, and Chongqing, with emphasis on real estate development, an area that is most attractive to overseas Chinese for investment. Why these three cities? I think it’s because the central government believes it will be able to keep control of corruption in these locales. If it is effective, other cities will open up as controls are in place.

Perhaps a brief review of real estate tax and regulatory issues is a good idea. A Plus, the monthly magazine of the Hong Kong Institute of CPAs, published an article about this in its July issue.

JiangZhuFang (Circular) 171 of 2006 set the basic policies for real estate FDI. Its formal title is ‘‘Opinions on Regulating the Entry into and the Administration of Foreign Investment in Real Estate Market.’’

While this circular permitted both wholly foreign owned enterprises as well as joint ventures, I get the feeling that the central government is encouraging joint venture projects in the future.

Circular 50 of 2007 tightened requirements for approval of foreign real estate investment. The local ministry of commerce will only grant approval if the investor has obtained land use rights or building ownership, or has entered into a sale and purchase agreement to obtain such rights or ownership. ‘‘Round trip’’ investment structures, in which domestic Chinese investors use their overseas funds to make domestic investments, while not prohibited, are being strictly regulated.

Capital requirements are being imposed and enforced. As per Circular 171, capital requirements based on the size of the project are set as follows:

• for an investment of $3 million or less, 70 percent must first be deposited in China;

• for an investment between $3 million and $10 million, either $2.1 million or 50 percent of total investment must be provided up front (I wonder who is permitted to put up front only $2.1 million on a $10 million investment);

• for investments exceeding $10 million, 50 percent must come to China first (to be deposited at J.P. Morgan in Chengdu?); and

• any foreign currency debt for construction purposes must be registered with the SAFE before approval.

Suppose a foreign venture sets up in one of the favored second-tier cities to build and operate a real estate venture and that this venture turns a profit and is ready to distribute dividends. Well, Guoshuihan (Notice) 81 of February 2009 implements procedures regarding payment of dividends to foreign investors.

While the withholding tax rate on dividends stands at 10 percent, there are some tax treaty jurisdictions where this amount is reduced to 5 percent. To take advantage of the dividend tax reduction:

• the recipient of the dividends must be a tax resident of that treaty jurisdiction;

• the recipient must be the beneficial owner of the dividends (how this affects a European ownerinvestor of a Hong Kong corporation investing in China is still open to conjecture); and

• the dividend must be regarded as either dividend or other equity income under Chinese domestic tax law.

Here’s the catch: Other conditions may be stipulated by the State Administration of Taxation (SAT); thus, the law can be changed as policy by the tax bureaucracy rather than by formal law.

What never fails to amaze me — and China is not alone in this because both the U.S. and U.K. do the same thing — is how when the economy seems to be in the tank and logic dictates that you want to see as much money as possible in the hands of consumers so they will spend, governments seem to tighten the noose of taxation and try to squeeze that extra yuan renminbi (or greenback or pound) out of the small guy to make up for the government’s shortfall.

An article in China Stakes on September 18 discussed the mooncake coupon tax. For the Mid-Autumn Festival, which coincides this year with National Day, these small pastries filled with lotus seeds and egg yolks are a tradition. For this year’s festival, the Chinese government is collecting taxes on the mooncake coupons. The coupons that are redeemable at the better stores and hotels are being counted as part of salary and are considered taxable income.

According to the latest SAT data, tax authorities found CNY 41.3 billion of evaded taxes for the first seven months of the year; over half of this was evaded in June and July! This was not evasion as much as the SAT simply having to collect its tax quota to pay for itself. The cost of tax collection is under 1 percent in most developed countries. It is 8 percent in China. Why is that? Inefficiency? Lack of transparency? Probably both and a whole lot more.

During the 1997-1998 Asian financial crisis, China had to collect CNY 100 billion more in 1998 than in 1997. To meet their quotas, local offices of the SAT resorted to all sorts of methods, not all of them legal or ethical. They levied taxes in advance on ‘‘predicted’’ income, pressuring banks to lend to the prepayers so the local tax quotas could be met. This created yet another triangular debt of loans that could not be paid off, thus forcing the central government to once again bail out the banks. Tax collection employees who could not meet their quotas were forced to relinquish some of their wages to pay for their part of the shortfall.

We, the smaller taxpayers, had to take five subscriptions each of all the local offices’ new monthly periodicals on taxation. I argued successfully that because I was a one-person firm, I should not be required to purchase more than one subscription of each new tax periodical.

And, my friends, this year, I will argue with both my physician and the SAT. I will have a mooncake . . . and I refuse to pay tax on my mooncake coupon!

Happy 60th Anniversary, China. Happy Mid- Autumn Festival, everyone.

Until next time,

RELATED ARTICLES:

• Protect the equity in your home
• Asset Protection Plans
• C.A.L.M. Introduction
• Get educated on Asset Protection