Investment zones have been an important vehicle for foreign investors to gain preferential treatment, but what do they really offer in terms of benefits?
There are several different types of zone in China. The largest are the five special economic zones (SEZs) in the south of the country – the cities of Shenzhen, Xiamen, Shantou and Zhuhai, along with Hainan province. Each of these cities retains the right to enact its own legislation without reference to the provincial government, and all offer substantially reduced corporate income tax rates – 15 percent of profit against the national standard of 33 percent.
SEZs are closed areas and special permission is required by mainland Chinese to enter them. They have attracted some of China's best young talent and entrepreneurial skills, but costs are comparatively high. Shanghai's Pudong new area is a similar structure, but without the travel restrictions, and is targeted mainly at the financial and trade services sectors.
Next in line are the open cities, originally 14 eastern seaboard cities, already advanced in infrastructure and trade, and originally designed to operate as gateways into China's interior. The list was expanded in 1992 to include all provincial capitals and all cities in border regions. Such cities contain many sub-zones offering SEZ-style tax incentives ? but be cautious, as not all have actually obtained central government approval to do so and they can be run rather as local autocracies.
Far better regulated are the economic and technical development zones (ETDZs). These are much wider in geographical scope than the SEZs, covering major northern cities as well as smaller coastal regions. Like SEZs, they have the right to create their own regulations concerning business activities, but are targeted more at technology-intensive industries.
Local authorities have the right to approve projects valued at up to US$30m. Corporate income tax for investments in ETDZs with a term in excess of 10 years can be levied at 15 percent, and at 24 percent for projects with a shorter term. While some of the more established zones are now fairly expensive, ETDZs in second-tier cities are often more welcoming to the foreign investor and can be a source of good service at a still reasonable price.
High-tech development zones (HTDZs) are permitted within open cities to offer tax incentives to foreign investors specifically in the high-tech area. However, local governments often have a very loose definition of 'high-tech.' Some, such as the HTDZs in Xiamen and the Zhongguancun district in Beijing, have maintained high standards.
HTDZs offer similar investment criteria to SEZs, but the tax incentives here are administered by the Ministry of Science and Technology rather than the local authorities. They are often situated close to universities, which can make them a good source of young talent. It is advisable to shop around, as the quality of these zones varies between excellent and poor.
China currently has 15 centrally approved free trade zones (FTZs), most of them along the eastern seaboard and sited on or next to major ports with customs and import/export facilities. The main activities of such zones are warehousing and export processing. They offer duty-free status on imports and exports and also provide local or foreign currency settlement on transactions conducted within the zones.
There is a proliferation of local level zones in China, and they can be a risky proposition as many of the open cities and other urban areas rushed to offer their own incentives to lure foreign investors. Only 10 have so far been centrally approved, with others being unofficial zones offering unauthorised incentives.
It is wise to ensure that the policies of such zones are accepted by the central government; otherwise, they may run the risk of being withdrawn later. Check also on the financial status of the local government's investment vehicle, as income tax discounts in unofficial zones are not authorised, which means that it comes out of the pockets of the local government. It would be wise not to rely on such incentives prevailing in the longer term.
Private investment zones have also increased in number over the past few years, often recognisable by being designated as investment `parks' or 'cities.' Several are joint Sino-foreign operations with negotiated leases for large tracts of land that then offer improved management and infrastructure due in part to the experience (and money) of the foreign investor. Regulatory activities typically remain with the local government, and they are commonly adjacent to ETDZs as a sort of `sub-zone' where, for an increased premium or management fee, service is superior. These are emerging across the country as their popularity spreads.
Most zones offer tax incentives and holidays, typically a combination of things that FIEs are entitled to in any case, plus some local benefits. Wholly foreign-owned enterprises (WFOEs) and joint ventures are normally entitled to tax holidays at 100 percent of corporate income tax (national rate 33 percent, with regional differences) for the first two years of profitability, and a further three years of profitability at 50 percent, regard-less of where they set up.
FTZs, ETDZs and HTDZs will typically have a corporate income (profit) tax rate of 15 percent and they may offer exemption from land-use costs. Some zones, in particular those in western regions, offer tax holidays for periods in excess of the five-year norm. Others only levy income tax at a rate of 10 percent if the FIE is exporting more than 70 percent of its production. There is quite a variety, so it is wise to shop around.
Most of the different types of zones offer similar types of deals on tax incentives, holidays etc, but to varying degrees. Other benefits to look out for include the ability to cut through red tape, the quality of infrastructure, proximity to clients and good transport infrastructure, ability to hire labour and the price of land. Some zones also offer deals for certain industries, such as pharmaceuticals, agriculture or computing.
Investment zones are important for foreign investors in China. Quality and incentives do vary, but the best zones are a great help in dealing with China's bureaucracy and in getting you started. The variety of different zones acts as an incentive for foreign investors and as a barometer for China to manage and understand on a local basis how to develop its market economy, and thus can offer some unique flexibility that may not be available elsewhere.
Despite doom-laden talk with the advent of WTO accession and Xinhua's recent report that some tax incentives would be phased out for FIEs in SEZs and other areas, investment zones are here to stay and will play a vital role in China's development. Some inland, northern and western provinces are now beginning to offer excellent long-term incentives through the continuing use of such zones.
Free trade zones
The first free trade zone was established in 1990, in Waigaoqiao, in the Pudong district of Shanghai. Now, such zones line the east coast, all offering bonded warehouse, local port and import-export facilities.
The flexibility offered by local governments in attracting investment can mean a relaxation in the normally stiff wording that applies to a company's `scope of business,' being the legal definition in China of a company's recognised activities. This can make it easier for WFOEs located in an FTZ to obtain permission to offer services such as consultancy, architecture, recruitment and software design, than would be the case elsewhere in China. For customs purposes, FTZs are sited within bonded zones and therefore are not actually `physically' in China hence the flexibility.
The drawback here is that office buildings are functional rather than purpose built, which may not offer the image a service company wants to project. To get around this, you may want to establish your billing entity as a WFOE in an FTZ, then establish a representative office as the marketing wing in a downtown area. Companies registered in FTZs cannot establish outside an FTZ, but only within other FTZs.
For manufacturing and processing operations, FTZs typically offer factory and warehousing facilities, which can be tailored to a company's needs. Being based in an FTZ means goods can be imported duty free, processed, then re-exported duty free.
`Export' into China can be accessed through the use of an FTZ's in-house import/export facility, often at preferential rates, although goods then entering China from the FTZ would be subject to duty and VAT at 17 percent. However, if your customer is a foreign-invested enterprise (FIE) in China, it would be able to claim back the customs duty if the product supplied is an essential component part of their manufacturing process, and for those products then re-exported by the FIE of which that component was then a part, a rebate on VAT as well.
For foreign component manufacturers servicing larger FlEs in China, FTZs offer an opportunity for substantial duty savings that can be passed on to a client. Some FTZs offer rebates on VAT, but be careful not to take this as a long-term benefit. Of China's 17 percent VAT, 12.5 percent must be remitted to the central government, while the remainder is allocated for local government use. If offered VAT refunds, it is this money the local officials are providing to you a situation frowned upon by Beijing and which may be withdrawn later if the central government bans the practice.
This article is reproduced with the kind permission of Dezan Shira & Associates. For more information about investment in China, visit its website on www.dershira.com.