Richard Hoffman of consulting firm ECOVIS China discusses the ongoing allure of the country for new and expanding foreign enterprises
Right now, what are the biggest incentives for a company thinking about expanding into China?
From the government side, there are not really new legal and tax incentives to come to China right now. And China is a very big market and different areas have different kinds of incentive plans, especially special economic zones that attract foreign direct investment. Here I think that one of the economic zones that really is very active is the special economic zone in Tianjin. They’re really actively attracting foreign direct investment. What they’re doing is they give certain tax incentives and provide real estate for a discounted price.
You also mentioned in a recent report that increasing domestic demand was also shifting China’s economy away from “merely a cheap manufacturing country.”
That’s right, yeah. Right now China has heavier labor cost and production cost, and it’s not a place to cheaply produce products anymore, it’s now a place to sell your high quality products. That’s a very big difference to five to ten years ago. I’m from Germany so, you know, in Germany there are famous cars, we produce BMWs, Mercedes, Audi and other high-end luxury cars. And China is now by far the best market to sell these luxury cars. It’s not only related to cars, I think luxury products are being widely sold in the Chinese market – it’s very attractive right now.
So what are some of the opportunities that the new shift is offering investors?
You can see an increase in the population of Chinese that have the money to buy new products and I think that if you have say a very good value product, if you have a technical product, a high value product it’s a very good market now.
Wholly foreign-owned enterprises (WFOEs) are now the most common option for foreign investment here. Which industries now have the most WFOEs, and where are entities like joint ventures still required by the government?
WFOEs are by far the most attractive vehicles for foreign investors. You’re always 100% in control of the finances. It’s all you. In certain industries you still need a Chinese partner. In certain industries or businesses it’s better to have one because they can bring in the network or client base that’s kind of important for you, or land or the financial power that you might need to have. In some industries it’s required. For example back to the car industry – if you’re producing cars, if you’re producing airplanes, if you’re in the education business, then a Chinese partner is required.
What are some of the problems that WFOEs run into, both in the market and in terms of regulations, if there are any?
So first of all, you must have the right business [type], you must have the right business idea, and this must be covered by the same business [type], and secondly, the main problem we see is actually an underestimation of the capital for foreign investment. So when you set up your WFOE, you’re required to report certain capital – logistics capital, registered capital – to the government. This is the capital that you can work with in China. However, if you run out of that capital, bringing fresh capital from overseas can be a bit tricky, a bit difficult. The State Administration of Foreign Exchange has strict control over every foreign currency, and that’s why it’s very difficult for foreign companies to bring in more capital. It’s important to consider your cash flow in China when you start up or run a business here.
And you also describe in the report Foreign Invested Commercial Enterprises as being mostly foreign-owned with limited liability, so they’re similar to WFOEs. Could you elaborate a little on the distinction between the two?
WFOE is the general term for any business that you run by yourself – it could be a consulting company, it could be a manufacturing company, or it could be a trading company. If it’s a trading company we call it a FICE, that’s generally how it works. However, FICE really just means it’s a trading company – a joint venture could also be a FICE.
You also mentioned some other requirements including a yearly audit and foreign currency inspection report, things like that. How much of a hurdle are those processes for smaller companies that maybe don’t have a large enough legal team on hand to have expertise?
The difficulty is, one, monthly compliance, that means you have to do the accounting and bookkeeping on a monthly basis, and this can be quite expensive for a small firm. So normally we would say if you hire one accountant, you’d better hire two, to better control over it, to have a bit of consistency. Because you never know – if one accountant is leaving you, you’ve got to have a backup. That makes it quite expensive. We suggest that if you’re a small enterprise it’s better off to outsource your accounts to a company that specializes in that, that has a team which provides consistency and quality of services. It makes it much less expensive and much better to run a company here at less cost. And secondly, the annual services required – tax record information, foreign currency inspection, etcetera – these are required and it’s something that even a small entity has to go through. It’s just one of the requirements. There’s nothing really you can do to avoid it, it’s a government requirement.
On a similar note, in 2008 the Enterprise and Income Tax Law came into effect, and I believe brought foreign enterprises under the same sort of tax scheme as domestic ones. What impact has that had on businesses here? And have there been any other tax code developments since then?
Formerly all foreign income companies only had to pay 60 percent of the corporate income tax or were fully exempted, and due to the reform of 2008 all Chinese and the foreign companies are treated equally. We all have the same tax burden. The other big difference we’ve had, starting two years ago, is the value-added tax (VAT) reform. VAT is the big reform that’s been affecting everyone running a business in China, from local companies to foreign companies, and it makes the VAT calculation a bit more complicated, more complex. However, in the end it saves you taxes. It follows the European model, and you can credit you input VAT against your output VAT, not only in the product sales but also sales in the service industry, which is quite a big advantage.
In the report you also discussed the issue of supply of skilled labor as being one of the other big issues that foreign investors face in China, and one of the pieces of advice you give is to develop your brand as an employer. Could you go a little more in depth into this, about what that entails really?
In China, generally speaking, people are very happy to work for a big brand – a big law firm, a big factory for cars or sportswear – big, international brands. So this is something that they take home to their family, and the family members can say ‘my husband,’ ‘my father,’ whoever, ‘works for Coca Cola,’ ‘BMW,’ you name it. They’re happy, they’re proud of it. Even if maybe their salary might not be as great as at other companies, these so-called non-branded companies that are not so well known. So this is kind of a branding issue. You have to train your team, you have to explain to them what is important in your own firm, what is the benefit of working for your company, and this helps with the loyalty of people on the staff and with avoiding high turnover.