Tax incentives offered to distribution centres and trading companies located in Waigaoqiao Free Trade Zone (FTZ) in the Pudong district of Shanghai have changed recently. Until the end of last year, they mainly consisted of a 25 percent refund on net value-added tax (VAT) paid and a 100 percent refund on enterprise income tax paid during the first two years from the issuance of the business license. Companies were also given a refund equal to 50 percent of this tax paid in the following three years under certain conditions.
With effect from January this year until the end of 2005, existing and newly established distribution centres/trading companies located in the zone will receive certain subsidies. Under the latest 10th five-year plan, if such companies have import/export turnover accounting for more than 15 percent of their annual sales, have traded bonded goods within Waigaoqiao FTZ and their operating period is more than 10 years, they will receive subsidies on VAT and enterprise income tax paid.
Existing companies will receive subsidies equivalent to a 12 percent refund on VAT paid and around a 33 percent refund on enterprise income tax paid. Newly established companies will receive subsidies equivalent to an 18 percent refund on VAT paid and around a 93 percent refund on enterprise income tax paid for the first two years and a 33 percent refund for the remaining years. The applicable income tax rate is still 15 percent but the local income tax rate of three percent is waived.
Setting up a distribution centre/trading company in Waigaoqiao FTZ would appear to have greater tax advantages than setting up in other locations or free trade zones. This is good news for existing companies in Waigaoqiao, since such subsidies would reduce their tax burden. Since the tax incentives are more favourable for newly established companies, it is expected that there will be a new flow of investment in setting up such companies.
However, those foreign investors who are planning to set up distribution centres/trading companies in Waigaoqiao FTZ must be careful about the state's taxation policy before making a decision. Recently, the central government in Beijing has reiterated that local governments have no authority to grant tax holidays or tax refunds that are not in line with central government policy. The current subsidies provided by Pudong finance bureau may be considered as a kind of tax refund that is not in line with the cur-rent state taxation policy.
As China is expected to enter the World Trade Organisation by the end of this year, the central government may decide to take stronger measures to improve the consistency of its taxation policy. Should it consider such subsidies provided in Waigaoqiao FTZ to be against the central taxation policy, the scheme would have to be banned. This may affect the competitive edge of companies in Waigaoqiao since it will increase their tax burden.
Those foreign investors interested in setting up distribution centres/trading companies in Waigaoqiao FTZ should carefully study their distribution structures and tax implications in case there is a change in the subsidies scheme. An alternative investment structure may need to be considered under such circumstances. Since the current investment regulations still do not allow foreign investors to set up a wholly foreign-owned trading company outside of the free trade zones, more foreign investors are likely to choose Waigaoqiao as an interim location to set up their trading arms in China under the current investment regulations.
This article was prepared by Bill Chan, partner and Jim Chung, senior manager of, PricewaterhouseCoopers, Hong Kong.