China has become a production power-house over the past 20 years and is now one of the world's largest trading nations. In the first five months of 2003, total exports and imports climbed nearly 40 percent year-on-year to reach US$65.4bn.
But while demand for quality and integrated transportation and logistics service providers is strong, these sectors are still dominated by domestic firms whose management concepts remain in their infancy. As China liberalises its trading and distribution sectors over the next three to five years as part of its WTO commitment, restrictions on foreign ownership will he relaxed.
Most logistics functions in China are currently handled by enterprises in-house. In future, more of these functions will be outsourced to third-party service providers as companies strive to achieve cost savings.
Meanwhile, major domestic logistics companies are seeking tie-ups with foreign investors to enhance their international capabilities, while medium-sized operators want to grow by attracting capital to exploit the licenses they possess.
In July 2002, new regulations on foreign investment in the logistics sector became effective. They permit foreign investors to form equity and contractual joint ventures with a maximum foreign ownership of 50 percent to engage in the following activities:
The minimum registered capital for the creation of logistics enterprises is US$5m
and they can only be set up in one of the trial areas: the municipalities of Beijing, Tianjin, Shanghai and Chongqing; Zhejiang, Jiangsu and Guangdong provinces; and Shenzhen special economic zone.
The Ministry of Foreign Trade and Economic Cooperation (Moftec), now incorporated into the new Ministry of Commerce, issued new regulations last December that increased the maximum foreign ownership in freight forwarding from 49 percent to 75 percent. The minimum registered capital for a new foreign-invested international freight forwarding agency is US$lm and it requires at least five personnel who have been engaged in international forwarding agency business for at least three years or with appropriate qualification certificates. Such an enterprise may engage in the following activities:
In November 2002, the Ministry of Communication and Moftec jointly issued a new regulation to increase the maximum foreign ownership level of a Sino-foreign road transportation joint venture to 75 percent from 40 percent. Since then, foreign investors have been permitted to engage in: road passenger transportation in the form of equity joint ventures; or road cargo transportation, freight forwarding and unloading, warehousing and some other joint venture auxiliary services.
Despite these recent relaxations, foreign investors are still faced with several hurdles. While the Ministry of Commerce is the main approval authority to drive the above regulations, fully-fledged logistics, freight forwarding and transportation companies need to obtain various approvals licenses from other supervisory authorities, including the Ministry of Communications, Civil Aviation Administration of China, the China State Post Bureau, Customs and local authorities. A lack of coordination, inflexibility and local protectionism among these authorities exacerbates the problem for foreign investors. Furthermore, the relevant regulations and requirements of various authorities are not very transparent.
Though foreign investors are allowed to own a majority stake in road transportation and international freight forwarding enterprises, they may still be reluctant to form joint ventures with Chinese partners because of concerns about handing over technical and management expertise to potential future competitors. They may also find it difficult to acquire the remaining shares from the Chinese partners once the regulations allow 100 percent foreign ownership. One possible solution would be to include a clause to allow foreign investors to buy out the remaining shares of the joint ventures, hut such a clause might not be enforceable in every instance.
Under the domestic Enterprise Income Tax (FIT) Law, newly established domestic transportation enterprises are entitled to a one-year exemption and one-year 50 percent reduction in FIT, from the start of operations. For domestic enterprises, the normal EIT rate at 33 percent would apply.
More preferential tax treatment could he available to domestic enterprises that are converted to foreign-investment enterprise' (FITs). According to foreign EIT law, FITs engaged in communication and non-passenger transportation would he qualified as 'production enterprises'. FITs that own their own transportation vehicles and warehouse facilities to provide direct services to customers would also be qualified as production enterprises. They can enjoy the following preferential income tax treatments:
Enterprises engaged in transportation and logistics would normally be subject to business tax at a rate that varies depending on the specific type of business. The rate applicable to businesses involved in transport agency, warehousing customs clearance agency and constancy would be 5 percent, compared with 3 percent for transportation activities. The tax authorities would generally consider enterprises engaged in the provision of transportation/logistics services through their own transportation means as being engaged in transportation business, and would thus be subject to business tax at 3 percent.
It is also common for enterprises engaged in transportation or logistics to be granted licenses to operate only within a particular city, such as Shenzhen; for cross-city provincial business, they may need to subcontract part of the services to other enterprises.. The local tax authorities may only treat the portion of the services income in relation to services performed in Shenzhen as transportation in nature and be subject to 3 percent business tax. The portion of services income outside Shenzhen may be regarded as 'agency business' and he subject to 5 percent business tax.
Multiple business tax is a common inefficiency for transportation and logistic enterprises but proper planning can mitigate such tax exposures and yield savings. For cross-border businesses, business tax should be imposed on the portion of revenue related to services performed within China. For transportation enterprises that carry passengers or cargoes from China to overseas locations and trans-ship passengers or cargoes to other transportation enterprises overseas, the taxable turnover should be the balance of transportation charges for the whole journey less the charges paid to the sub-contracted transportation enterprises.
It is very common for transportation logistics or freight forwarding enterprises to subcontract part of their services to other transportation enterprises especially those involving cross-city or cross-province businesses. Based on a new tax circular issued jointly by the Ministry of Finance and the State Administration of Taxation, approved enterprises can secure a deduction in the corresponding transportation fees paid to other companies from the gross transportation fee received for the calculation of business tax.
In light of recent relaxations, foreign investors should revisit their entry or expansion strategies to capture new opportunities:
Written by Pertnia Tam, partner and Jeremy Ngai, senior manager of Pricewaterhouse Coopers ' China tax services division in Hong Kong.
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