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China: Corporate Investment

Foreign Investment Regime

Prior to 2004, foreign investment into China, although welcomed, was restricted in various ways, both in terms of structure and in terms of sector. Then, partly in response to a perceived need to be more encouraging, and partly in order to gain admission to the World Trade Organization, China gradually began to loosen up. By now, most sectors are fully open, and there are few remaining restrictions.

China made concessions in a number of areas in order to gain access to the WTO:

  • Foreign companies are gradually being permitted to enter the telecoms industry.
  • China junked regional restrictions on foreign insurance companies, allowing them to provide health insurance, group insurance and pension/annuity services anywhere in China.
  • 100%-foreign-owned companies are allowed to engage in retailing and wholesaling in China without geographic restrictions.
  • China now allows foreign retail participation in JVs in the five special economic zones (SEZs) of Hainan, Shantou, Shenzhen, Xiamen and Zhuhai, as well as the cities of Beijing (the capital), Dalian, Guangzhou, Qingdao, Shanghai and Tianjin.
  • Foreign banks are gradually being allowed greater scope for their investments in permissible business and geographic areas. Overseas banks, which were previously limited to doing business in local currency with foreign companies, are now permitted to conduct business in the local currency with Chinese enterprises and this is being extended to renminbi business with local individuals.
  • JVs with minority foreign shareholdings may engage in fund management on the same terms as Chinese businesses.
  • Foreign securities companies may establish fund-management JVs and hold ownership of up to 49%.
  • The requirements for law firms operating in China have been relaxed, although there are still some restrictions.
  • Professionally licensed accountants, previously subject to mandatory localisation requirements, have unrestricted access to the Chinese market.

Until 2008, there were quite substantial tax incentive programs aimed at encouraging foreign investment, particularly in high technology sectors. Foreign investors were treated more leniently than equivalent domestic firms, from a fiscal perspective. But the Unified Enterprise Taxation regime brought into effect in that year largely removed the differences.

Before 2008 (see below), foreign investment enterprises (“FIEs”) of a production nature that expected to operate in China for more than ten years could apply for an exemption from income tax for two years, beginning from the first profit-making year, and a 50% tax reduction in the following three years. Starting from January 1, 2002, income derived from projects funded by additional capital injection was entitled to receive a tax holiday similar to a newly formed FIE if the projects fell within the “Encouraged” category of the new Industry Catalogue and the additional capital injection amount reached either of the following.

  • At least US$60 million.
  • At least US$15 million and at least 50% of the original registered capital.

A range of other reductions and exemptions was available, subject to certain criteria. A reduced income tax rate of 15% was possible for production FIEs in the Economic and Technological Development Zones and for enterprises engaged in production or business operations in the Special Economic Zones. A tax rate of 24% was possible for production FIEs located in the different economic open zones, depending on the location of the project.

The Chinese authorities established special preferences for projects involving high-tech and export-oriented investments. Priority sectors included transportation, communications, energy, metallurgy, construction materials, machinery, chemicals, pharmaceuticals, medical equipment, environmental protection and electronics.

Foreign investors sometimes had to negotiate incentives and benefits directly with the relevant government authorities; some incentives and benefits were not conferred automatically. The incentives available included significant reductions in national and local income taxes, land fees, import and export duties, and priority treatment in obtaining basic infrastructure services.

Foreign enterprises transferring technology inside China were exempted from business tax; if the technology is advanced and with preferential conditions, the enterprise income tax was exempted with the approval of the taxation department under the State Council. Income obtained by foreign-invested enterprises (including research and development centres set up with foreign investment) through technological transfer was exempted from business tax.

China encouraged reinvestment of profits. A foreign investor could obtain a refund of 40 percent of taxes paid on its share of income, if the profit was reinvested in China for at least five years. Where profits were reinvested in high-technology or export-oriented enterprises, the foreign investor might receive a full refund.

In 2008, China unified the income tax treatment of domestic and foreign enterprises with the new Enterprise Income Tax Law (the “New Law”). The New Law, effective from January 1st 2008, provides for a 25% statutory rate that applies to both domestic and foreign-funded enterprises and, subject to transition relief, enterprises that have enjoyed preferential treatment. Many foreign-funded enterprises will face higher rates due to the new unified rate and the loss of tax holidays and certain other incentives, but new and high-technology enterprises may still benefit from a 15% rate.

The cabinet said that the new law would be phased in over five years. Companies that paid income tax of 15% paid 18% in 2008, 20% in 2009, 22% in 2010, 24% in 2011 and 25% from 2012.

Companies that are exempt from taxes or have concessional rates will retain their preferences until the original expiration date.

Companies can make a one-time choice of the tax system that will be most beneficial.

The cabinet said the transitional steps targeted companies registered with industry and commerce administrations before March 16, 2007.

Companies in the western part of the country weren't affected by the new law but continue to enjoy preferential rates under regulations jointly issued by the Ministry of Finance, the State Administration of Taxation and China's Customs authority.

Also, the country offers incentives for key high-tech companies registered in special economic zones, including Shenzhen, Zhuhai, Shantou, Xiamen and Hainan, as well as in Shanghai Pudong New Area, on and after January 1st, 2008.

These companies must have proprietary technology and must comply with a range of requirements to be classified as high-tech enterprises.

For earnings collected within their district of registration, such companies would be exempted from corporate income tax for the first two tax years and pay income tax of just 12.5% from the third to the fifth tax years. Gains from outside these areas must be calculated separately.

Also included in the New Law are international taxation concepts wholly or partly new to China: the determination of residence under the “managed or controlled” concept; controlled foreign corporations; cost-sharing agreements; thin capitalisation; and deemed paid foreign tax credits. The New Law also strengthens transfer-pricing administration. The New Law only provides a framework of general tax provisions. Important details on the definition of numerous terms are left to the detailed implementation regulations and supplementary tax circulars.

In addition to the loss of tax holiday and reduced rate benefits, some withholding tax rates also increased under the New Law.

Hong Kong is the largest “foreign” investor in Mainland China, but with China’s WTO entry making the operating environment more transparent and predictable, firms increasingly are investing directly in the Mainland. As part of this trend, Shanghai is emerging as a major alternative to Hong Kong as a regional headquarters for foreign investors in China, although China’s limitations on currency convertibility continue to present problems for many investors, regardless of investment form, destination within China or origin.

China attempts to guide new foreign investment towards "encouraged" industries and regions. Over the past seven years, China has implemented new policies introducing incentives for investments in high-tech industries and in the central and western parts of the country in order to stimulate development in those less developed areas. A Catalogue of Foreign Investment took effect January 30, 2012, replacing the 2007 Catalogue. The catalogue designates sectors in which foreign investment are encouraged, restricted or prohibited. Unlisted sectors are permitted.

According to an accompanying regulation to the catalogue, projects in “encouraged” sectors benefit from duty-free import of capital equipment and value-added tax rebates on inputs. The same regulation states that approval authority for “restricted” investments rests with the relevant central government ministry and may not be delegated to the local level. For a number of restricted industries, a Chinese controlling or majority stake is required. Industries in which foreign investment is prohibited include national defense, firearms manufacturing, most media content sectors, and biotechnology seed production.

China's WTO membership has certainly made for fundamental changes in the country's degree of engagement with other parts of the world. China has frequently resorted to the WTO's dispute mechanism, as have its trading partners, often with an outcome not in China's favour. In December, 2009, for instance, the WTO's Appellate Body confirmed that China's restrictions on the importation and distribution of certain copyright-intensive products, including films for theatrical release, DVDs, music, books and journals, are inconsistent with China's WTO obligations.

The ruling was the result of a dispute procedure initiated by the United States in April 2007, in which Washington sought to address three significant market access concerns.

First, the US accused China of prohibiting foreign enterprises and individuals from importing reading materials, audiovisual home entertainment products such as DVDs, music and other sound recordings, and films for theatrical release. The WTO panel report found that China's key importation restrictions on these products were inconsistent with its obligations under its WTO Accession Protocol. The panel also found that China's restrictions were not justified by the exception in the General Agreement on Tariffs and Trade (GATT) 1994 related to the protection of public morals.

Secondly, China prohibits foreign enterprises from distributing certain reading materials and from distributing music electronically. The US also believed that China imposes discriminatory operating requirements on foreign-invested distributors of reading materials and DVDs. The WTO panel report found that these prohibitions and discriminatory operating requirements were inconsistent with China's obligations under the General Agreement on Trade in Services.

Thirdly, the US complained that certain imported products face more burdensome requirements before they may be distributed in China than domestic products. The panel found that because of these requirements, China discriminates against imported reading materials in several significant ways in breach of the national treatment obligation in the GATT 1994.

"Today America got a big win," commented US Trade Representative Ron Kirk. "We are very pleased that the WTO has found against China's import and distribution restrictions on US movies, music, DVDs and publications."

"The Appellate Body's findings are key to ensuring full market access in China for legitimate, high-quality entertainment products and the exporters and distributors of those products," Kirk continued. "US companies and workers are at the cutting edge of these industries, and they deserve a full chance to compete under agreed WTO rules. We expect China to respond promptly to these findings and bring its measures into compliance."

The Appellate Body report, published December 21, called on China to eliminate the discriminatory treatment that US distributors of certain products face – such as discriminatory operating term and capital requirements – as well as to allow US companies to partner with Chinese enterprises in joint ventures to distribute music and other sound recordings over the internet.

"This case is also an important part of our efforts to combat intellectual property piracy," Kirk noted. "The panel and Appellate Body findings ensure that legitimate American products are granted market access so that they can get to market and beat out the pirates. This finding helps to ensure that America's creative ingenuity and innovation are protected abroad."

Chinese news agency Xinhua reported that China's Ministry of Commerce "expressed regret" over the loss of the appeal against the WTO ruling. According to the report, ministry spokesman Yao Jian said in an online statement that the characteristics of cultural products determined that they should be managed differently to other imports.

It is not always true, though, that legal pressure is necessary to compel China to open itself to international trade. In April, 2010, Western firms were able to welcome a decision by Beijing to ease procurement rules that effectively prevent foreign firms from supplying the Chinese government with computers and other technological equipment.

The procurement rules, known as China's 'indigenous innovation' policy, were drawn up in 2009, and required companies to obtain patents, trademarks and other intellectual property in China before any other country. However, in a draft of the new rules released for public comment on April 12, the Chinese government appeared to have relaxed these requirements so that companies which have legal rights over the intellectual property of the products may qualify to take part in the procurement process.

The European Chamber of Commerce in China said that the rule change represents "an important sign that policymakers in China recognize the role that fair competition plays in developing and enhancing China's high-tech capabilities," although it remains to be seen how the new rules work in practice.

Concerns remain over China's general stance towards the rest of the world, and in July, 2010, Chinese Premier Wen Jiabao reassured foreign investors of the stability of the country’s investment climate, countering fears that China’s economic environment is worsening.

Wen issued the reassurance at a meeting with Germany’s Chancellor Angela Merkel and a group of business leaders from China and Germany and added that his country would not block the export of rare metals needed in the manufacture of computers and mobile phones.

Wen countered an allegation that China’s investment environment had deteriorated by saying “I think it is untrue”. Senior executives from some of Germany’s biggest companies were present at the meeting, including Siemens and BASF, the chemical giant.

The business leaders called on the Chinese government to handle foreign investment with fairness and equity, though the value of trade deals between China and Germany already exceeds USD100bn, with foreign investments up by USD12.5bn in the last year.

Speaking to reassure foreign investors, the Premier said: “Those that have entered China all enjoy national treatment, as do Chinese companies, whether they are a foreign-funded company, a joint venture or a joint stock company”.

The meeting was seen as important as China is the world’s biggest exporter of rare earth minerals and is the EU’s largest trading partner.

 

 

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