China is getting close to joining the World Trade Organisation (WTO), although the full benefits of membership will not be available to foreign investors until three to five years later. Even so, accession will present immediate opportunities and challenges to market participants.
In order to comply with the WTO's principles on most favoured nation, national treatment and transparency, China must reform its current tax laws and practices, and apply them consistently. For example, some local governments may grant preferential tax treatment to individual domestic enterprises and foreign investment enterprises based on different criteria and sometimes confusing interpretations of tax laws.
Upon WTO accession, the central government is likely to take steps to tighten tax compliance by all enterprises and to ensure more consistency in the application of tax laws by the local tax authorities. Uniform tax laws applicable to both foreign invested and domestic enterprises will be essential to guarantee a level playing field.
The possible gradual removal and/or reduction of many existing trade barriers and restrictions would enable investors to consolidate their current operating structures in China into simpler, more cost-effective and efficient business operations. However, all these restructuring exercises could trigger transactional tax costs and demand careful planning and implementation.
Loss of revenue
The reduction of import duties for various merchandise over a specified number of years is another major feature of WTO accession. This will lead to a loss of revenue for the Chinese government, so a strengthening of tax and customs collection would definitely follow. Moreover, whether to combat competition from foreign investors or to make their location more attractive, local authorities will require significant funds to support their enterprises or improve their infrastructure and social programmes. Tax authorities will face intense pressure to tighten tax collection and administration. In fact, it is anticipated that a revised legislation for the Administration of Tax Collection will be promulgated soon with the likelihood of heavier fines for tax evasion and non-compliance of withholding obligations.
On the other hand, to slow down market access for foreign companies or certain imported products, there could be a broadening of the charging scope and an increase in consumption tax rates for certain consumer items. As consumption tax rates are often high, affected industries should keep a close watch on developments in this area.
Changing business horizon
China's investment climate is ever changing. The influx of foreign investment has had a great impact on state-owned enterprises (SOEs), stimulating demand for better financial reporting and management skills. In the meantime, competition is heating up and domestic enterprises are taking steps to better prepare themselves for the challenges brought by China's commitments to the WTO. Many are consolidating their businesses, making strategic mergers, expanding operations internationally and exploring e-commerce opportunities.
Currently, there are regulations that aim to protect domestic enterprises and guard assets against foreign control. Whether these will be toned down or altered is uncertain. One example of new legislation is the recent promulgation of regulations by the Ministry of Information Industry to require all internet content providers in China to register and obtain approval within a few months; otherwise, the business will be prohibited. The definition of those businesses requiring approval is wide and unclear. In addition, the central government is subsidising SOEs to invest in infrastructure projects from pipelines to cable networks, areas that may remain under state control for quite a while. Hence, winners and losers from the future structuring and reforms are still to be seen.
On a positive note, government ministries are making efforts to foster a climate that encourages foreign investment. They have been working to simplify and improve their administrative system, investment regulations, customs processing, foreign exchange administration and judicial process. Some are liberalising domestic markets and allowing foreign investors greater regulatory flexibility in conducting business in China. For example, Beijing has expanded holding companies' business scope to permit trading of products produced by their invested enterprises and also greater financing latitude for major projects.
Moreover, many local governments are competing to gain competitive advantage as investment destinations for foreign investors. They are focusing on offering preferential treatment in areas not covered by the WTO, improving infrastructure and offering commercial service support, such as foreign exchange services, logistics support and special commercial ties.
E-commerce and the fast growing information technology industries may also pose profound issues for China in areas ranging from security of information to protection of tax revenue and enforcement of law. Hong Kong can play an important role here in raising capital and providing management and technology know-how for internet-related businesses, to help prepare China for its accession to the WTO.
In order to comply with WTO rules, changes and reforms to China's existing tax laws and foreign investment policies are well within reach. Local tax and customs authorities will increasingly tighten their enforcement of laws. Foreign investors should review their tax compliance status and transfer pricing policies before it becomes too late to avoid penalties. Tax optimisation planning should be implemented to avoid non-compliance risk, reduce tax burden and regulatory costs in the future.
New regulations are being drafted and existing regulations modified to comply with WTO commitments. There will be a new investment climate that fosters foreign investment to operate in a freer economy, trade goods and consolidate operations. Foreign investors should be able to exercise more control over distribution channels and have better access to their target markets. Foreign investors should review the impact of China's accession to the WTO on their current business strategies, keeping abreast of regulatory and tax developments both at the national and local levels.
This article was written by Petrina Tam, partner, and Danny Po, senior manager from the China Tax Services department of PricewaterhouseCoopers.