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Is Property Tax in The Cards for China and India?

By Laurence E. Lipsher - Email Editor

MAY

Dear Valued Reader,

There are 10 cities in China that, over the next couple of years, must experiment with and implement some form of municipal tax change that would involve property taxation. Shenzhen needs it now. Actually, Shenzhen needed it last year because that thriving municipality finally started seeing the well run dry. It has run out of land to sell. With no land sales, there's no municipal revenue. With no revenue, who's going to get paid - and how?

I recently met with approximately 30 Beijing-based civil servants, fresh out of graduate school, to discuss my recollections of how the property tax worked in California. True, I haven't lived in California for 20 years, but for the 22 years preceding my departure, I was a bona fide property-owning property tax payer. That's also when I held my first "in-charge" job as a CPA, working on a Tulare County government audit less than six months after a major Los Angeles county tax assessor scandal had taken place. (Ah, what a time I had — perhaps the only time in my professional career I experienced the "power" of an accountant who struck fear in the minds of loyal, capable civil servants.)

During my presentation, I explained the valuation and assessment functions, the tax collection functions, and the checks and balances used to prevent corrupt practices and provide a fair method of appealing valuations. Simultaneously, while we were meeting, there were two other meetings taking place that same day in Beijing, within walking distance of where we met, the National People's Congress and the Chinese People's Political and Consultative Conference (CPPCC).

According to the March 17th South China Morning Post, Zong Qinghou, CEO of the Hangzhou Wahaha Group, the richest mainland resident, and a delegate to the CPPCC, said a property tax would hurt homeowners. Yes, additional taxes will hurt all taxpayers. Yet a property tax will have far less impact on homeowners and occupiers than on speculators and would be much more helpful in stabilizing real estate prices for the vast majority in China who aspire to home ownership but for whom the cost of real estate is rising far more rapidly than their incomes or savings.

Entrepreneur Lu Guanqiu, China's 19th wealthiest individual (according to the "Hurun Report," publisher Rupert Hoogewerf's popular annual listing of who has what in the P.R.C.), concurred, as did Pan Shiyi, number 24 on the Forbes Asia wealth list and, like the other two, also a member of the CPPCC. The ones who have properties are the ones with the power to implement the tax, so it's very unlikely the tax will become law, Shiyi said.

Just what are all these wealthy individuals doing at annual national political gatherings in Beijing, held by the Communist Party? Blame that, my friends, on former president Jiang Zemin, who in 2002 changed party doctrine, encouraging private entrepreneurs to join the party. These individuals are now voicing opposition to government initiatives from within the system. Gee, I always thought that the concept of "rich communist" was oxymoronic.

The fact is that an annual levy on property would likely yield a far more reliable revenue stream, making municipalities much less dependent on land auctions that alone helped prices rise 10.7 percent, year on year, for the month of February. This is the fastest pace of property price increases in well over two years.

An annual levy on property would likely yield a far more reliable revenue stream.

There was actually a member of the CPPCC who did not oppose property tax implementation, Delegate Wang Chaobin, a Henan Province property developer (who, it appears, made no one's "rich list"), said in the South China Morning Post that "the whole world pays property tax. China's economy must be linked with the whole world in order to become prosperous."

Yes, a property tax is, in my opinion, needed. Yet the implementation process is going to be much more difficult than anyone can imagine. A large, new bureaucratic infrastructure would have to be created for assessment, appeals, collection, and anticorruption, one city at a time, to see how it all can be developed — with Chinese characteristics.

It is coming to China. The only matters of concern are when, where, and how. The anticorruption element is going to be the biggest problem. An in-depth analysis in the February 2nd South China Morning Post points out how corrupt practices can distort things. I wrote about a 7.8 percent increase in property prices for the month of December 2009. This obviously affects the assessed value of property. It isn't so, says Peggy Sito, who wrote the South China Morning Post analysis. There appears to be a huge disparity between officially reported data and reality because of a "yin-yang," dual contract subterfuge to avoid taxes in the secondary market. In reality, the secondary market in the larger cities of China grew by over 60 percent in 2009.

Firsthand property sales are generally not involved in this scam, which is known to local governments but is not curtailed, for fear of putting a damper on the economy. Firsthand properties are generally sold by developers and listed on the stock exchange, where reflecting a lower sales price will affect the listing on the stock exchange and the listed corporation's bottom line. Yin-yang contracts refer to public and private contracts. The former is fake, at a lower price. It is the one reported to the government. The latter, the "real price" contract, is strictly under the table and is a method of avoiding taxation. According to Sito, the banks in China go along with this.

Under the law, secondhand properties are subject to a personal income tax at 20 percent of the gain. On top of that, there is a 5.5 percent transactions gains tax on sales of homes held for less than two years. Stamp taxes and miscellaneous fees add another 4 percent to the price, and because all these costs are generally passed on to the buyer by the seller (who is ultimately responsible for paying the tax), there is generally an agreement between buyers and sellers for two contracts.

Another frequent practice in Shanghai is the listing of 25 percent of the sales price as "furnishing fees" because those are not subject to taxation. While the Guangzhou municipal government is aware of this also taking place in Guangzhou, municipal authorities have said they will start investigating this activity. Will there be any penalties for this type of tax avoidance? I doubt it.

It's not, of course, my opinion that matters regarding implementation of property taxation. That lies in the seat of power, with the ultimate decision makers in Beijing. The central government's Ministry of Land Resources plowed CNY 1.6 trillion in revenues into the Chinese economic stimulus package, 40 percent of this was generated by the sale of land, through the central government, with the revenues going to the provinces and cities. I think this portends problems because so much tax-equivalent revenue flowed into the banking sector to lend quickly, primarily to the state-owned entities, which grabbed all available real estate to build on with someone else's money. Insanity? I think so. Yet it seems to be working. However....

In a Business Times article on February 8th, Neil Mc-Donald, an insolvency attorney with Lovells in Hong Kong, said, "There are literally trillions and trillions of renminbi of, frankly, defaulting loans in China that no one is doing anything about." If, at some point in time, the banks need a bailout, it will obviously have to come from the central government, leaving nothing for those cities that have sold all their land. City by city, as the need is most acute, that's how there will be a property tax in China, no matter what those rich Communists think.

Property tax in Hong Kong? Not in my lifetime. The magnates who own, operate, and control my favorite city will never let it happen. Hong Kong operates on the real estate standard, with the price of real estate - if Hong Kongers had their way - always going up, never down. And yet Hong Kong taxation is very much in the news lately. On March 22nd Hong Kong announced the signing of a double tax avoidance agreement (DTAA) with Brunei. To make the OECD white list, you've got to have a certain number of treaties and tax information exchange agreements, and not necessarily arrangements with big jurisdictions. I cannot think of tax treaty benefits to be derived from a Brunei-Hong Kong treaty, other than inching one's way off of the gray list and onto the white list. The same day, Hong Kong and the Netherlands announced the signing of a DTAA, and, who knows, I might actually read this one And what I will read, no doubt, is the Hong Kong-Indonesia DTAA, announced on March 23rd. This one is of interest because it appears to contain favorable treatment for Hong Kong-owned entities doing business in Indonesia. This should be of interest to P.R.C. companies wishing to avail themselves of tax breaks that previously were not available. Now all I need is the time to read - and hopefully comprehend - this tax treaty.

Let's get back to property taxation and the other functions it performs. This time, let's take a look at Macao. On March 22nd, another South China Morning Post article discussed a Macanese government decision to fill in a lake in order to build a public hospital. Land reclamation will be performed at the government's expense, while adjoining properties of either real land or previously filled-in land lie vacant and undeveloped. This has aroused some concern in Macao because of its inability to seize land from speculators. Without a property tax, once a parcel of land is sold by the government, the government loses control and the speculator-developer has absolutely no incentive to do anything but wait until it can either afford to develop the property or has the financing in place. Somehow, I think that an assessed market valuation and annual tax would curb this practice.

Macao's land law requires government land sales to be carried out through public auction. Yet, since the 1999 handover to the P.R.C., only a small number of the more than 400 sites sold by the government have actually gone through the bidding process. Without open bidding, sites have often sold at below-market prices, according to the South China Morning Post. In fact, the paper reported that one vacant 10.6 hectare parcel near the soon-to-be-land-filled lake is owned by Chui Sai-cheong, older brother of Macao Chief Executive Fernando Chui Sai-on. The land presumably was sold to him without a bidding process, at a belowmarket price.

Shenzhen and Shanghai, I believe, will implement property taxation measures ahead of the other cities. Shenzhen needs it because the city already has run out of land to sell. Shanghai, in its desire to control development, is taking an aggressive approach toward developers that do not fulfill their project commitments.

Beijing? That's too tough one to predict. An annual property tax would likely have meant that the luxurious resort at which I spoke in south Beijing would probably have never been built, the entire area of business parks being developed in south Beijing (through the courtesy of a phenomenally large bank loan stimulus package - unregulated, of course) would never have been constructed with a property tax in place. There will be a property tax in China - eventually — because there is a necessity for the municipalities to have revenue as well as a demand from the urban classes to curb speculation and make housing affordable.

Property Taxation in India

As long as we're on the subject, India's proposed direct tax code contains provisions that would change the method of taxation on "income from house property" to "simplify the determination of taxable income and eliminate any scope for litigation," according to an article in the March 23rd Economic Times. The code would have a new method of computation of income from house property.

According to the code, the property owners would compute the income from house property, even if the property is rented out for business. Under current provisions of the Income Tax Act, rent of an "inseparable building," along with plant, machinery, and equipment, is taxable under either business income or other source income. Under the proposed direct tax code, property owners would be the ones paying the tax. Presumptive rent would be 6 percent of the ratable value, as fixed by the municipality - or the cost of construction or acquisition of the property if the municipality does not fix the presumed rental value. Section 26 of the proposed direct tax code provides for deduction from the gross rent. Deductions would include previously paid property taxes, service tax on rent, and a 20 percent allowance toward repairs and maintenance.

While the direct tax code in India would establish a property tax there, the likelihood of one actually being implemented in China is much greater simply because of the time it would take for this to finally happen in India. We're still waiting to see if a definitive date for implementation of the general service tax will ever arrive.

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ABOUT THIS EDITOR:

Laurence E. 'Larry' Lipsher is an American CPA who has specialized in taxation in Asia for 23 of the 42 years he has been working within the accounting profession....

Full Bio - Email Laurence E. 'Larry'